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As much as investors claim to build portfolios around historical assumptions, they can have selectively short memories. Even the most experienced aren’t completely immune to recency bias, that is, the tendency to give greater importance to recent events than to the long term.

The recent performance of defensive equities is an interesting test case for such potential misperceptions. A historically unparalleled bull market marches through its second decade as government institutions have taken steps to mitigate any meaningful long-term correction. Amazingly, even the worst global health crisis in a century represented only a brief ‘speed bump’ of a few months before recovering. Why bother with lowering the risk in your equity allocation when that risk is so consistently rewarded? Because a longer-term view paints a very different picture.

While equity investors have been fortunate to sustain only brief drawdowns since the Global Financial Crisis and persistently accommodating economic, fiscal, and monetary conditions have smoothed over headwinds, history shows that a general risk-on environment cannot last forever. That same context tells us that when the next black swan arrives, defensive equity can make a substantial impact in preserving your capital and stabilizing your equity outcomes.

Has This Happened Before?

As we covered in our previous paper, Making Sense of Defensive Equity Indexes, ‘passive’ implementations of this asset class come in many shapes and sizes. For the purposes of this paper, we’ll use the most popular instance, the global developed market iteration of MSCI’s Minimum Volatility Indexes, as our proxy, due to its greater market presence, optimization-based approach, and long-term track record.

There’s no ignoring the magnitude by which the MSCI World Minimum Volatility Index has lagged its cap-weighted parent, the MSCI World Index, in the last few years. In fact, the all-time three-year annualized low in relative return (-8.61%) occurred at the end of 2021.

But – you guessed it – we’ve been here before. The previous low (-7.85%) occurred in March 2000, just before the sky-high valuations of speculative tech names gave way to a 46% drawdown in the MSCI World. What happened over the following three years? The MSCI World Minimum Volatility proceeded to outperform the MSCI World by an average of 11.14% per year (see the chart below).

Fig_1_MSCI World Min Vol Index vs MSCI World Index

The next chart further illustrates the cyclical nature of this asset class relative to the broad market, which should be part of any investor’s clear-eyed view of what they’re getting. Underperformance is to be expected during the strongest and most extended rallies, but there has generally been a payoff on the other side for sticking it through.

Fig_2_Market Return vs Defensive Equity Excess ReturnWhat Should We Expect From Defensive Equities?

We’ve explored how the largest periods of defensive equity underperformance vs. the cap-weighted index has preceded the worst of market downturns, as well as the strongest periods of defensive equity outperformance. But what about all the periods in between? And how do defensive equities add value to an equity allocation over a full market cycle? Download the full paper for a deeper look into defensive equity performance expectations and benefits.

Download Paper

 

This information is issued by Intech Investment Management LLC (Intech) and is intended solely for the use of wholesale clients as defined in section 761G of the Corporations Act 2001 (Cth) and is not for general public distribution. Intech is permitted to provide certain financial services to wholesale clients pursuant to an exemption from the need to hold an Australian financial services licence under the Corporations Act 2001. Intech is regulated by the United States Securities & Exchange Commission (SEC) under U.S. laws, which differ from Australian laws. By receiving this information you represent that you are a wholesale client.

The views presented are for information purposes only and should not be used or construed as investment, legal or tax advice or as an offer to sell, a solicitation of an offer to buy, or a recommendation to buy, sell or hold any security, investment strategy or market sector. Nor do they purport to address the financial objectives or specific investment needs of any individual reader, investor, or organization. The views are subject to change at any time based upon market or other conditions, are current as of the date indicated, and may be superseded by subsequent market events or other conditions.

Past performance is no guarantee of future results. Investing involves risk, including the possible loss of principal and fluctuation of value. As with all investments, there are inherent risks that need to be considered. Information that is based on past results or observations is not necessarily a guide to future results, and no representation or warranty, express or implied, is made regarding future results.

There is no guarantee that any defensive equity strategy will outperform a benchmark over the long term with lower volatility. These strategies may underperform the benchmark during certain periods of up markets and may not achieve the desired level of protection in down markets.

Indices are not available for direct investment; therefore, the performance shown does not reflect the expenses associated with the active management of an actual portfolio. Index returns include the reinvestment of dividends and other earnings.

MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices or any securities or financial products. This material has not been approved, reviewed, or produced by MSCI.

The information expressed herein is subject to change based on market and other conditions. The views presented are for general informational purposes only and do not purport to address the financial objectives or specific investment needs of any individual reader, investor, or organization. This information should not be used as the sole basis for investment decisions. All content is presented by the date(s) published or indicated only, and may be superseded by subsequent market events or other reasons.

References made to individual securities should not constitute or form part of any offer or solicitation to issue, sell, subscribe or purchase the security.

MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein, if shown. The MSCI data may not be further redistributed or used as a basis for other indices or any securities or financial products. This material has not been approved, reviewed, or produced by MSCI.