Modern Portfolio Theory (MPT) is a statistical formulation of the risk reduction benefits of diversification.  Under Modern Portfolio Theory, risk is measured quantitatively as volatility or beta.  Volatility is the variance or standard deviation of an asset’s returns.  Beta is the sensitivity of an asset’s returns to the return of the overall market.  High-beta and high-volatility stocks are more risky than low-beta or low-volatility stocks.  So far, so good.

In addition, Modern Portfolio Theory predicts that a diversified portfolio of risky stocks should generate higher returns than a diversified portfolio of less risky stocks.  But the evidence of the last forty-two years is just the opposite.  Low-beta and low-volatility stocks actually have the higher returns according to this recent paper in the Financial Analyst Journal.  Something to consider the next time you are tempted to sell your “boring” slow moving stock to buy a trendy “high flying” momentum stock.