Fidelity: When it pays to consider low volatility strategies

Fidelity: When it pays to consider low volatility strategies

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Volatility has spiked in equity markets as the world grapples to respond to the threat of the new Omicron Covid-19 variant. In the face of a riskier macro environment, strategies designed to minimise volatility may find their time to shine again after several quarters of underperformance. A low volatility approach can help to mitigate losses when equities sell off, but also offer investors a way of staying invested if the rally resumes.

Low volatility equity strategies have had a hard time keeping up with recovery rallies over the last few quarters. For example, the MSCI AC World Minimum Volatility index has delivered just over half the returns of the MSCI AC World index since March 2020. Investors have favoured technology companies and, more recently, cyclical sectors like financials and energy, which are typically under-represented in a ‘low volatility’ portfolio. 

But the macro environment is becoming less supportive for equities as the economic cycle matures, forcing investors to re-focus on risk management. The CBOE Market Volatility Index spiked in November for its biggest monthly gain since early 2020, when the Covid-19 pandemic started. This week’s Chart Room looks at the benefit of low volatility equity portfolios during periods of market instability.

Less accommodative monetary and fiscal policy, combined with high valuations, are leaving equities vulnerable, but it’s impossible to predict when a downturn may start, and investors can end up sacrificing good returns by de-risking too much, too soon. This is where a low volatility approach to equity investing can help: it offers a way to mitigate downside risk while still participating in the upside potential of stocks.

With minimum volatility seen as a defensive factor, such strategies usually involve buying stocks based on their estimated volatility and correlations with other equities. We divided rolling three-month returns over the last 20 years into three groups, based on the highest, middle and lowest third of observed three-month volatilities, and compared the average performance of the MSCI AC World Minimum Volatility index against that of the benchmark MSCI AC World index. Our research shows that during periods of high market volatility, low volatility strategies tend to outperform by reducing the drag of unstable returns.

0312 Fidelity