Potential downside exposure in changing risk regimes presents a significant threat for investors, as it leaves them exposed to the “curse of compounding”. Not only do negative returns represent a loss in value, but they also require a portfolio to earn even higher returns just to get investors back to a breakeven point.

Asset managers have taken a number of steps in recent years to address this problem, including the use of alternative assets, low volatility strategies, and even tactical asset allocation.

Alternative assets, such as absolute return strategies and private equity, often come with high fees, liquidity risk, and hidden equity beta. Adding low volatility strategies offers important equity diversification and risk reduction, but these have somewhat static, lower beta exposure and generally don’t participate fully in a market’s upside. Tactical asset allocation can help navigate these risk regimes, but this introduces market-timing challenges. This approach can also increase implementation costs and raise governance issues.

What if investors could reduce the overall risk of equity investing without sacrificing returns? A variable beta strategy seeks to do just that. These types of strategies are designed to adapt automatically to equity risk regimes in order to protect on the downside and participate in the upside. A variable beta strategy is a hybrid of active core and low volatility equity strategies, and are designed to reduce risk exposure when it counts, thus providing better long-term risk-return profiles.

In risk-on environments, the equity beta of a variable beta strategy may be closer to 1, while in risk-off markets the beta adjusts downward, reducing systematic risk as seen in Figure 2. Ideally, adjustments are made in a systematic and disciplined manner to improve consistency and smooth the equity return profile without the requirement for unreliable market-timing decisions.

The value proposition for equities changes with a variable beta strategy, offering the potential for improved compounding and downside protection that asset owners seek during periods of market turbulence.

To learn how variable beta strategies adapt within a strategic model, download our most recent paper: “Can Strategic Asset Allocations Adapt to Markets?”

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) 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.

The hypothetical illustrations presented are not real and have many inherent limitations. They do not reflect the results or risks associated with actual trading or the actual performance of any portfolio, and have 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. In no circumstances should the hypothetical results be regarded as a representation, warranty, or prediction that investors will achieve or are likely to achieve the results displayed or that investors will be able to avoid losses. The hypothetical results do not reflect the deduction of advisory fees and other expenses, which will materially lower results over time.

MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices or any securities or financial products. This article has not been approved, reviewed, or produced by MSCI.