BOOSTING THE PERFORMANCE OF LOW RISK INVESTING STRATEGIES: THE INTERACTION BETWEEN YIELD AND PROFITABILITY

Abstract

The debate of whether high-yield stocks offer superior returns continues to wage on. However, little deny its safe characteristics, with studies highlighting its ability to provide defensive cover in down markets. Profitable stocks, as measured by gross profits-to-assets (GP/A), have been recently demonstrated to possess the ability to outperform in both raw and risk-adjusted returns. Consequently, this begets the question of whether a combination of these two strategies will result in a superior portfolio which embraces both superior return performance and yet provide good defensive cover in unpredictable markets. To do so, this paper explores the interaction of both profitable and dividend yield effects, stress-testing its performance under various discrete states before documenting their long-run cumulative returns and alphas. We find that with the proposed combination, superior raw and risk-adjusted returns are observed. While increased volatility has been witnessed, this has been illustrated to be good (upside) volatility with the analysis of portfolio downside ratios. In addition, this strategy performed well in different discrete states, often registering the lowest return spreads amongst its peers to further demonstrate its defensive nature. To ensure the robustness of our empirical analysis, the long-run outperformance of high GP/A, high-yield portfolios was also established. The findings of this study hence sets the groundwork for a combination of equities that not only offer superior returns, but also considerable downside protection, presenting interesting implications for not only institutional investors, but the common man alike.