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We’ve enjoyed a historically long bull market, but it can’t last forever, of course. Recent volatility shocks and increasing political uncertainty serve as a reminder that corrections are difficult to predict, and impossible to protect against after the fact. Defensive equity strategies offer a long-term, strategic option to potentially mitigate those risks and their impact on multi-manager equity line-ups is clear, but how much of it do you really need?

What's Your Loss Tolerance?

Asset owners can use defensive equity strategies to substitute for either passive cap-weighted indexes or active long-only portfolios benchmarked to a cap-weighted index. But unlike traditional active strategies, defensive strategies focus on volatility reduction and lower drawdowns; therefore, the amount you allocate to your portfolio should be based on your willingness to tolerate losses.

Figure 1 demonstrates the drawdown effects that incremental allocations to a low volatility or variable beta strategy may have on your equity allocation. Asset owners with a low tolerance for large capital losses should allocate more of their equity holdings to defensive equity strategies. For example, over the last 20 years an investor unwilling to tolerate losses exceeding 40% should have allocated over 60% of his or her equity holdings to a low volatility strategy or about 70% to a variable beta strategy.


Largest Drawdown vs. Return for Hypothetical Global Blended Portfolios-1


New Frontiers

As seen in Figure 1, returns improved with incremental allocations to a low volatility or variable beta strategy. Combined with lower volatility, the higher returns offer higher Sharpe ratio potential. Yet, not all Sharpe ratios are created equally. Each of the two types of defensive equity strategies may improve it, but towards which part of the efficient frontier are they going to do so? Figure 2 demonstrates the effect incremental allocations to a low volatility or variable beta strategy may have on your risk-return profile when combined with a cap-weighted index allocation.


Volatility vs Return for Hypothetical Global Blended Portfolios 1999-2018


No Quick Fix

Of course, an investor’s time horizon matters too. The magnitude and duration of up and down markets can produce varying outcomes for these strategies. Most of these strategies tend to lag the market in sharp upturns because of the headwind faced due to beta lower than one. To make the most of their potential, asset owners should consider defensive equity strategies as part of their long-term policy allocation. These strategies are not short-term tactical solutions.

Learn More

Diversifying your equity allocation by adding defensive equity strategies is compelling, but managers use a variety of approaches to achieve those results. And a strategy name doesn’t tell the story. How do you distinguish between similar-sounding strategies? What’s more, how do they impact your overall portfolio? You can learn more by downloading our paper entitled, “Evaluating and Implementing Defensive Equity Strategies.”

 

Evaluating and Implementing Defensive Equity Strategies  A deeper look at defensive equity investing. Download Paper

 

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 results presented are 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 and has been prepared with the benefit of hindsight. 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 results shown. Hypothetical results do not reflect the deduction of advisory fees and other expenses incurred in the management of a portfolio.