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It’s scary out there today!

But ghosts and goblins have nothing on reaching fresh market highs during one of the longest bull markets in history. If you feel closer to the end than the beginning of this bull market, you may need to start facing your fears...

Do you just await the worst?

Do you pull back and run?

Don't Settle on a False Choice

We argue these questions pose a false choice for investors because you can find some middle ground with defensive equity investing. Defensive strategies attempt to perform well if markets crack while delivering participation in up markets. It allows you to confront your market fears on this scary occasion.

And we can offer a real example of how this works. Intech has been managing a global low volatility strategy since 2012, giving us 93 monthly returns to examine. Even in this “risk on” period, we can demonstrate how defensive equity strategies attempt to offer value.

We're Here for the Boos

Despite the bull market run, markets have definitely spooked investors a few times over the last several years. Below are monthly return frequency distribution charts for Intech Global Low Volatility vs. MSCI World Index (Figure 1). There are two obvious features of Intech Global Volatility to point out here:

  • Skinnier left tail: monthly returns to the downside are truncated.
  • Lower volatility: the range of monthly returns is narrower.

 

Figure 1

 

You can see that clients already in this strategy avoided some of the worst monthly returns of the market yet they still participated in the upside. It’s true that participation in the best returning months of market was less frequent, but we can show you why this is still better than getting circus peanuts in your trick-or-treat bag!

More Treat Than Trick

Investors have so internalized investing’s risk-return tradeoff that they trick themselves into believing that taking less risk results in less return. The commonly accepted thesis is that higher return generally requires more risk.

As we pointed out already, the Intech Global Low Volatility strategy illustrated above clearly has less volatility, so presumably returns should be lower. But most investors hold portfolios for more than one period, so this lower volatility actually serves to fuel the “magic” of compounding by avoiding volatility drag.

Over time, the distribution above produced the returns below. Below we compare Intech Global Low Volatility to its MSCI World Index benchmark and Global Large Cap Core equity peers from eVestment.

 

Figure 2

 

To put it simply, defensive equity investing is mostly about two things: (a) recognizing and avoiding uncompensated risk and (b) minimizing drawdown. This one-two punch offers the potential of equal – or even better – performance than capitalization-weighted benchmarks.

Sorting Your Candy

There’s nothing worse than a trick-or-treat bag full of the same thing (especially circus peanuts). We all want variety and that’s especially true in your overall asset allocation. So how might defensive equity strategies affect your mix?

Given the substantial portion of global equities in an institutional portfolio, replacing even a third with a defensive equity strategy can still have a material benefit to your overall risk-return profile and funding status.

In Figure 3, we examine the effects within a hypothetical example of a modern institutional multi-asset portfolio: 50% public equities, 30% bonds, 10% real estate, and 10% private equity, rebalanced annually. Comparing a 100% passive exposure to global equities versus those where we replace 1/3 of the equity allocation with a hypothetical low volatility or variable beta strategy, the results represent genuine value over time in terms of capital growth, with less volatility along the way.

 

Figure 3

 

While we’ve kept the total public equity portion of the overall portfolio static in this example, the reduction in total portfolio risk frees up risk budgets for increased exposure to public equities or other return-seeking assets.

Here's a Fang-tastic Offer

Diversifying your portfolio by adding defensive equity strategies is clearly appealing, but where do you start? Managers use a variety of approaches to achieve defensive equity results. How do you distinguish between them? How does your tolerance for loss affect your allocation to defensive equities? We invite you learn more by downloading our paper entitled, “Evaluating and Implementing Defensive Equity Strategies.”

 


 

Disclaimer: Intech Investment Management LLC (“Intech”) is a specialized global asset manager registered under the Investment Advisers Act of 1940 that applies advanced mathematics and systematic portfolio rebalancing to exploit a unique and reliable source of excess returns and risk control – stock price volatility. Intech is a subsidiary of Janus Henderson Group plc (NYSE: JHG) and is affiliated with its subsidiaries and affiliates. 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. Performance results reflect the reinvestment of dividends and other earnings. Portfolio performance results shown are 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. The composite includes all actual fee-paying accounts managed on a fully discretionary basis according to the investment strategy from inception date, including those no longer under management. Accounts meeting such criteria enter the composite upon the full first month under management. For periods of less than one year, performance is not annualized. Reporting currency is USD unless otherwise noted. The gross performance results presented do not reflect the deduction of investment advisory fees. Returns will be reduced by such advisory fees and other contractual expenses as described in each client’s individual contract. The net performance results presented reflect the deduction of model investment advisory fees, and not the advisory fees actually charged to the accounts in the composite. The model advisory fees deducted reflect the standard fee schedule in effect during the period shown, applied to each account in the composite on a monthly basis. Standard fee schedules are available upon request. Actual advisory fees paid may vary among clients invested in the same strategy, which may be higher or lower than the model advisory fees. Some accounts may utilize a performance-based fee. Global Low Volatility Composite includes all fully discretionary separately managed portfolios invested in this strategy. The strategy pursues a risk-managed approach to construct a diversified portfolio of global large capitalization securities. The benchmark is the MSCI World Index. The objective is market-like returns as compared to the benchmark over the full market cycle, with a total volatility (standard deviation) considerably below that of the benchmark. The composite was created in February 2012. The MSCI World Index is a free float-adjusted market capitalization weighted index that is designed to measure global developed market equity performance. The Index returns are provided to represent the investment environment existing during the time periods shown and are not covered by the report of independent verifiers. For comparison purposes, the index is fully invested, which includes the reinvestment of dividends and capital gains. The returns for the index do not include any transactions costs, management fees or other costs, and are gross of dividend tax withholdings unless otherwise noted. Composition of each separately managed account portfolio may differ from securities in the corresponding benchmark index. The index is used as a performance benchmark only, as Intech® does not attempt to replicate an index. The weightings of securities within the portfolio may differ significantly from the weighting within the index. The index is not available for direct investment; therefore, its performance does not reflect the expenses associated with the active management of an actual portfolio. Prices assigned to investments are published prices on their primary markets or exchanges. Non U.S. securities are translated into U.S. dollars using the 4:00 P.M. London spot rate. However, if a significant event takes place between the close of the local market and the close of the U.S. domestic market, a security may be fair valued. Investments are subject to certain risks, including currency fluctuations and changes in political and economic conditions, which could result in significant market fluctuations. These risks are magnified for portfolios that include emerging 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 report has not been approved, reviewed, or produced by MSCI. Hypothetical performance results presented are for illustrative purposes only. Hypothetical performance is not real and has many inherent limitations, some of which, but not all, are described herein. Hypothetical performance results are presented for illustrative purposes only. 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.

Data source is Intech throughout unless otherwise indicated.