With increased interest in defensive equity investing, asset owners and consultants need constructive ways to evaluate results from managers. Methods for quantifying the expectations and effectiveness of defensive equity strategies range from the common to the more esoteric or convoluted. We’ve summarized some of the more helpful measurements below.
History Test
Given the frequently asymmetric nature of these strategies by design, a sample size of results over a full market cycle is necessary for setting expectations across all market environments. Reducing these statistics to a single annualized figure for the entire period may work as a shorthand to summarize their long-term outcomes, but rolling periods (e.g., one, three, or even five years) can help illuminate variations over time within those different environments.
Unfortunately, despite the substantial growth in defensive equity strategies over the last 10 years, live track records available for many defensive equity strategies are still relatively short. Even long records exist only during the current bull market. You may also need to supplement live track records with back-tested results. Low volatility indexes also suffer from this problem.
Below are metrics you might expect to find on the back of their baseball card, along with some interesting, less-common but still-insightful measurements.
What About Benchmarks?
Using a low volatility index as a benchmark for defensive equity strategies seems like it would make sense, but it’s less than straightforward under closer scrutiny. For one thing, which index approach is valid? It’s arbitrary to endorse one index over another given the wide range of construction methodologies. These so-called indexes are actually active strategies – they all have distinct stock selection processes, often have wide return dispersion and some even lack transparency.
Instead, many defensive equity investors simply use cap-weighted benchmarks and Sharpe ratio or Jensen’s (beta- adjusted) alpha to evaluate performance. Investors prefer Sharpe ratio if total volatility – both systemic and idiosyncratic risks – is most relevant. If only systemic risk is relevant, then Jensen’s alpha may be more appropriate. This practical approach recognizes that defensive equity investing isn’t about beating a defensive equity index; rather, it seeks a superior risk-return profile to cap-weighted benchmarks.
Dig Deeper
Evaluating results for defensive equity strategies may be straightforward to some, 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 will you ultimately implement these in your portfolio? You can learn more about our defensive equity offerings here.
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.
