It's been a scary year for low volatility strategies. Despite sharing common objectives – less volatility, less drawdown, and market-like return – they haven't all shared the same success. So why haven't we seen more returns like those for Intech Global Minimum Volatility FactorPlus?

Low Vol Strategies Aren't All the Same

Whether you're looking at active or passive low volatility strategies, you'll quickly discover that different designs yield different outcomes. Unfortunately, as an industry, we haven't done a great job helping you navigate the clutter among these strategies. A clear understanding of approaches can also clarify why many low volatility strategies underperform while others behaved as expected.

Quant vs. Fundamental

Explicitly low volatility equity strategies are generally quantitative. That said, some more traditional-looking fundamental strategies might grant defensive positioning as residual benefits to your total equity allocation. They may be dividend-focused or value strategies, but exhibit enough defensive-like behavior to attract investors seeking to complement growth strategies and de-risk equities, despite not necessarily targeting these outcomes.

Heuristic vs. Optimized

Among quantitative managers, the methods used to construct a portfolio are good differentiators. Broadly, there are two approaches: heuristic and optimized.

The heuristic, or rank-based, approach is more straightforward and transparent. Still, it may be prone to concentration risk due to the implicit exclusion of higher volatility stocks and overreliance on the lowest-volatility stocks.

The optimized approach is more complicated and successful outcomes using this approach are highly dependent on estimates of volatility and correlations, and the constraints employed. Nonetheless, optimization may be able to better avoid valuation or overcrowding concerns due to the inclusion of stocks that aren't strictly considered low volatility due to their attractive (i.e., low) correlations with others.

MSCI offers a naïve implementation of this optimized approach with MSCI World Minimum Volatility Index. A comparison of its cumulative performance to its parent index, MSCI World Index illustrates the efficacy of the approach and the impact of volatility reduction on long-term compounding.

Optimized+

As you might guess, we're fans of the optimized approach at Intech and offer several flavors of it, but Intech Global Minimum Volatility FactorPlus offers a twist on the approach. It attempts to improve on MSCI’s naïve execution of the approach – just as we seek to do with cap-weighted benchmarks. In doing so, we try to deliver the volatility reduction of a low volatility index and alpha.

As we so often point out, a portfolio's compound return is greater than its underlying stocks' weighted compound returns. The difference is the diversification effect, which is available from cap-weighted and low volatility indexes alike.

Intech Global Minimum Volatility FactorPlus attempts to unlock the alpha from the diversification effect present in MSCI Global Minimum Variance Index. Allowing for 200 to 400 bps of active risk, the strategy seeks this extra return by relaxing the index's constraints for greater diversification, using more timely volatility estimates, and rebalancing more frequently.

Index constraints have the goal of maintaining passive-like replicability and invest-ability (i.e., ETF development); unfortunately, they limit the index's ability to position away from the cap-weighted index and to adjust more frequently. And the MSCI index has a lot of them. Relaxing these constraints allows us to take a truly active approach to create a significantly more efficient portfolio.

To improve efficiency, we start with more timely estimates of volatility and correlation. MSCI re-optimizes their index with new constituents and weights just twice a year. In between reconstitutions, they maintain a covariance matrix with monthly updates, using the latest version at the time of the semi-annual optimizations. In contrast, our strategy re-optimizes with timely volatility estimates every month, enabling more frequent opportunities to replenish diversification and capture the rebalancing premium.

The overall result is to produce consistent excess returns while also managing active risk relative to the index – and, critically, do this while maintaining a similar level of volatility reduction.

How's Your Low Vol Experience?

We certainly believe there's potential to improve low volatility index performance with similar volatility reduction. Ultimately, however, investors expect low volatility strategies to compare favorably to cap-weighted benchmarks. Has that been your experience?

If not, we invite you to learn more about Intech Global Minimum Volatility FactorPlus. With three years of history and US$260 million in assets (as of September 30, 2020), Intech Global Minimum Volatility FactorPlus has delivered better risk-adjusted returns than both minimum volatility and cap-weighted benchmarks, as well as many Global Low Volatility peers.

Results aren't accidental. Intech Global Minimum Volatility FactorPlus employs several techniques we've outlined to drive toward what our clients expect from low volatility equity allocations. We invite you to learn more. Please download our latest strategy profile for Intech Global Minimum Volatility FactorPlus to learn more.

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 cannot guarantee future results. Investing involves risk, including the possible loss of principal and fluctuation of value. In addition, the proprietary mathematical investment process used by Intech^® may not achieve the desired results. Composite performance results include the reinvestment of dividends and other earnings, reflect time-weighted rates of return using daily valuation, include the effect of transaction costs (commissions, exchange fees, etc.), and are gross of non-reclaimable withholding taxes, if any. For periods of less than one year, performance is not annualized. Reporting currency is USD.
Gross results presented do not reflect the deduction of investment advisory fees and will be reduced by such advisory fees and other contractual expenses.
Net results reflect the deduction of model investment advisory fees, and not the advisory fees actually charged. The model advisory fees deducted reflect the standard fee schedule in effect during the period shown. Standard fee schedules are available upon request. Actual advisory fees paid may vary, may be higher or lower than model advisory fees, or consist of performance-based fees.
Index returns do not include any transactions costs, management fees or other costs, and are gross of dividend tax withholdings unless otherwise noted. An index is not available for direct investment; therefore, its performance does not reflect the expenses associated with the active management of an actual portfolio.
Investments are subject to certain risks, including currency fluctuations and changes in political and economic conditions, which could result in significant market fluctuations.
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 report has not been approved, reviewed, or produced by MSCI.