Downside risk and the performance of volatility-managed portfolios

Recent studies find mixed evidence on the performance of volatility-managed portfolios. We show that strategies scaled by downside volatility exhibit significantly better performance than strategies scaled by total volatility. The improved performance is evident in spanning regressions, direct Sharpe-ratio comparisons, and real-time trading strategies. A decomposition analysis indicates that the enhanced performance of downside volatility-managed portfolios is primarily due to return timing, i.e., downside volatility negatively predicts future returns. We find that employing fixed-weight strategies significantly improves the performance of volatility-managed portfolios for real-time investors. Our results hold for nine equity factors and a broad sample of 94 anomaly portfolios.