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Decline - I am not an Institutional Investor

In our previous blog, we covered whether prospective low volatility equity investors should be concerned about whether 2022’s drawdown is over, and whether more rate increases are a headwind to low volatility returns. While those are valid near-term questions, we believe the potential benefits of this asset class warrant a long-term perspective.

As we move out of the most severe extended bear period since the 2008 Global Financial Crisis, low volatility strategies have had their first real test in over a decade. While the market saw a couple of sharp downward moves during the 2015-2016 sell-off and again in 2018 due to monetary-tightening fears, these barely crested double digits and rebounded quickly. Even the exogenous shock of Covid-19 in early 2020 was erased in a few months. The conclusion: on a relative basis, most low volatility strategies performed well. As we covered in our paper, Defensive Equity: Tactical or Strategic?, low volatility portfolios may not always outperform during short, mild downturns, but they have a strong (R-squared > 0.6) predilection to outperform during long, severe drawdowns – exactly the kind that can make or break plan solvency.

This is central to their appeal. While it’s true that investors may not have always been thrilled with the idea of potentially leaving some returns on the table during the risk-on periods that dominated most of the past decade, low volatility performance on the downside can still make it worthwhile, resulting in market-like or better returns over a full market cycle, and lower volatility along the way. The figure below illustrates the give-and-take, but ultimately low volatility strategies typically capture several attractive risk attributes relative to a cap-weighted benchmark for many institutional investors:

  1. volatility reduction in all markets, and greater reduction in the most volatile environments;
  2. reduced upside capture, but even greater reduction in downside capture (opportunities for which are less frequent, but often sharper);
  3. significant drawdown protection from the worst declines.

Hypothetical Global Low Vol Strategy vs MSCI World Index_Fig_4

Equities tend to represent the largest source of risk in a multi-asset allocation for institutional plans; consequently, the ability to reduce risk without sacrificing upside over the long-term translates into significant improvements in risk-return outcomes. These can translate into material benefits in the preservation and growth of plan assets over time.

In the illustration below, we express these benefits within a multi-asset portfolio over the last 25 years. We constructed 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 one-third of the equity allocation with a hypothetical low volatility strategy, the results represent genuine value over time in terms of capital growth (a $100 billion starting value yields $50 billion more in value), with less volatility along the way. Furthermore, while we’ve kept the total public equity portion of the overall portfolio static in this example, the reduction in total portfolio risk opens the door for either reducing funding status volatility, or frees up risk budgets for the plan to seek increased exposure to more aggressive public equity strategies or other return-seeking assets.

Effects of Replacing 13 of Global Equity Allocation with Hypothetical Low Vol Strategy - Fig 5For those not already committed to low volatility equity exposure, it’s tempting to look at every major market decline as a missed opportunity to soften the landing. We sympathize: hindsight regrets can be painful. We hope we’ve provided a compelling case for long-term, strategic thinking around this asset class. Near-term market performance is hard to predict, but an effective low volatility strategy represents a persistent valuable, diversifying addition to any institutional investor’s equity lineup, representing real potential reduction in funding status volatility.

Is Now a Good Time for Low Volatility Equity?

Investors considering low volatility equities may be wondering: is the drawdown over? And are additional looming interest rate increases a headwind to their returns? Download the full paper for our historical analysis of questions at the forefront of potential low volatility investors’ minds.

Is it Too Late for Low Volatility?  Why Low Volatility Can Still Help Your Portfolio Download Now

 

 

The information expressed herein is subject to change based on market and other conditions and is issued by Intech. 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 for other reasons. Past performance is no guarantee of future results. Investing involves risk, including possible loss of principal and fluctuation of value. Indexes are unmanaged and cannot be invested in directly.

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.

Low volatility 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.

Indices are not available for direct investment; therefore, performance does not reflect the expenses associated with the active management of an actual portfolio.

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