Timing minimum-variance investment in the Canadian stock market

Hyeonjun Kim

Abstract

We contribute to the literature by introducing an explanation of the variation in idiosyncratic volatility (IVOL) anomaly return and its application to minimum-variance investing in the Canadian stock market. First, we find that the variation in minimum-variance exchange-traded fund excess return is better explained by the crowdedness of factor investing (and the following overpricing and market friction) than by the IVOL factor, which expands the state-of-the-art model. Second, we identify the crowdedness of factor investment by defining a novel time series indicator. Our indicator has a high predictive power for future factor returns and for the IVOL factor. Third, using the indicator and proxy for leverage constraint, we suggest a strategy of rotation between the Canadian minimum-variance exchange-traded fund portfolio and the Canadian stock market portfolio. This rotation strategy shows an excess compound annual growth rate that is more than 1% higher than the ex post high-performing spread between the two assets and is robust to high transaction costs. The long-only strategy is also considered to have a moderate index outperformance, enabling more practical implementation.