“The aim of the wise is not to secure pleasure, but to avoid pain.”
Recent volatility in equity markets may be unsettling to some investors. Skittishness about the stock market is understandable, especially in the context of the serenity in 2017. Volatility levels are relatively higher and risk is on the radar of investors’ consciousness again.
Historically, bonds have been the preferred asset class in times of turmoil. The bull market for bonds in the last 30+ plus years meant the tradeoff in returns wasn’t that much of a sacrifice. But, as the chart below shows, at current interest rate levels, bonds as a means of defense are less attractive than they’ve typically been.
In this context, we looked at defensive equity strategies as a means of lowering overall portfolio risk. The S&P 500 Low Volatility Index is the classic example of a risk-reducing strategy; the index tracks the 100 least volatile stocks in the S&P 500. As the chart below reflects, this index has consistently delivered less volatility than the S&P 500 from 1991 to 2017 on a 10-year rolling basis. Despite its lower risk profile, the S&P 500 Low Volatility Index has, anomalously, outperformed the S&P 500 in the 27+ years from 1991 to year-to-date 2018.
More recently, during this year’s two major market declines on February 5, 2018 (S&P 500: -4.1%) and October 10, 2018 (S&P 500: -3.3%), the low volatility index also lived up to its objective, outperforming the S&P 500 on both days.
Low Volatility is perhaps the quintessential defensive equity strategy, but it’s by no means the only one. Our new paper, Defense Beyond Bonds, provides a deeper discussion of risk-mitigating approaches to equity management.