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Global equities have enjoyed a historically long bull market – barreling through even a global pandemic. But the same low interest-rates that sustained the unprecedented growth have been a drag on pension funding levels. Exposure to equity returns remains a necessity to meet liabilities moving forward, while also representing a primary source of liquidity. At the same time, a market continually setting market highs may mean drawdowns are in our future – and the prospect of funding benefits out of equities in down markets can have outsized negative effects on long-term solvency.

Low volatility factor investing offers a potential solution: market-like returns with lower risk, in the form of reduced volatility and downside. MSCI’s Minimum Volatility Index suite offers a straightforward entry point in this space, and their backtested results represent the potential of the best-of-both-worlds outcomes that low volatility portfolios may promise.

f1 Index Performance

Minimum volatility indexes may have their long-term performance bolstered by a combination of a) better return compounding (lower ‘volatility drag’), b) under-weighting or excluding the highest-volatility stocks in the investable universe, and c) the capture of a rebalancing premium (as they are not buy-and-hold portfolios). Beyond that, they typically outperform in downturns or periods of market turmoil. This is an incidental and episodic source of outperformance, and sometimes only in backtests (index methodologies are sometimes re-tooled following the most significant drawdowns with the benefit of hindsight). In the absence of significant crises, or when market volatility is low, this outperformance may not be counted upon to cover implementation costs. Even during market crises, the turnover required for reliably navigating the market can result in overcrowded or concentrated trades that cost both return and risk reduction.

Because these indexes are intended for passive replication, their construction employs a number of rules and constraints to ensure they’re feasible in this role. These constraints, however, are compromises that should represent an opportunity for a skilled active manager to improve the risk-return outcome for their clients. We believe there are several dimensions in which an active manager can potentially better a minimum volatility index in a meaningful way. Here, we will focus on the possibility of providing additional return with a similar risk profile.

Happily, much like a traditional active manager can improve performance within a tracking error range against a cap-weighted index, so too an active manager can improve performance within a tracking error range measured against a minimum volatility index. Constraints with the goal of maintaining passive-like replicability and investability still inherently limit these indexes’ positioning away from the cap-weighted index. Relaxing these constraints allows a truly active approach to create a significantly more efficient portfolio.

f2 Active Management


More timely estimates of the stocks’ individual volatility and correlation relative to each other allow for consistently more diversified positioning. Freedom from the restrictive low-turnover and active constraints allows a much more adaptive and effective positioning and, combined with a more up-to-date and sophisticated rebalancing, unleashes the opportunity to harness the stocks’ individual price movements, or relative volatility (i.e., how they move relative to the total index) as a reliable alpha source. The overall result is to produce consistent excess returns while also managing active risk relative to the minimum volatility index – and, critically, can be achievable while maintaining a similar level of absolute risk, and downside protection, as that benchmark at the portfolio level.

f3 Hypothetical Min Vol

Follow the Funding Impact

We believe an active approach combined with minimum volatility indexes can add alpha while maintaining the more defensive risk profile, but the real-world benefit is in its impact on plan solvency. Learn more by downloading our eBook, “How to Improve Low Volatility Factor Investing Outcomes.”

How to Improve Low Volatility Factor Investing Outcomes  Learn how active managers can improve low volatility factor investing. Download Now


The information expressed herein is subject to change based on market and other conditions. The views presented are for general informational purposes only and are not intended as investment advice, as an offer or solicitation of an offer to sell or buy, or as an endorsement, recommendation, or sponsorship of any company, security, advisory service, or fund nor do they 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. Past performance is no guarantee of future results. Investing involves risk, including possible loss of principal and fluctuation of value.
Hypothetical performance shown is for illustrative purposes only. Hypothetical performance is not real and has many inherent limitations. It does not reflect the results or risks associated with actual trading or the actual performance of any portfolio. Therefore, there is no guarantee that an actual portfolio would have achieved the results shown. In fact, there will be differences between hypothetical and actual results. No investor should assume that future performance will be profitable, or equal to the hypothetical results shown.
In no circumstances should the hypothetical results be regarded as a representation, warranty, or prediction that investors will achieve or are likely to achieve the results displayed or that investors will be able to avoid losses. The hypothetical results include estimated trading fees, but do not reflect the deduction of advisory fees and other expenses, which will materially lower results over time. As with all investments, there are inherent risks that must be considered.
An index is unmanaged, is not available for direct investment, and does not reflect the deduction of management fees or other expenses. There is a risk/reward tradeoff that comes with investing in defensive equity strategies. These risk strategies are likely to underperform the index during periods of strong up markets and may not achieve the desired level of protection in down markets.
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.