Minimum volatility: Potential stability in the face of volatility

Volatility can appear with little warning. A minimum volatility strategy may help investors build more resilient portfolios in the face of uncertainty.

In 2018, investors showed a proclivity towards risk reduction, entrusting iShares to manage more than $7B of new assets in minimum volatility strategies alone[1]. Amazingly, nearly $6B of this $7B in inflows occurred in the 4th quarter[2], signaling a dramatic shift in investor sentiment to close out the year. What drove this shift in sentiment? We believe investors began to recognize that calm markets are receding, and that it is time to position for increased volatility moving forward.

In 2017, the median intra-day high of the VIX, a measure of volatility in the market, was 11. However, in 2018, we began to see this relative calm recede.  Volatility reared its ugly head early in the year with the VIX spiking to an intra-day high of 50[3] (more than double its long run median) on February 3rd. Again, in December, we saw similar bouts of volatility with intra-day spikes above 35. Indeed, we observe valid reasons for investors to be concerned when simply comparing last year to the one before it.

CBOE VIX Intraday high: 2017-2018

Despite the significant bouts of volatility in 2018, the average VIX intraday high was 18, below the long-term average of 20[4]. With heightened geopolitical concerns, ongoing trade wars and fears of slower growth unlikely to diffuse in the near-term, we believe that higher volatility is likely to persist.

Reduce risk at the core of your portfolio

In my conversations with clients, a recurrent theme is the reemergence of volatility and how investors are using Minimum Volatility strategies to position their portfolios for longer-term resilience. The iShares Edge MSCI Min Vol USA ETF (“USMV”), which tracks the MSCI USA Minimum Volatility Index (“Index”) is one such minimum volatility strategy which can help investors position their portfolios to better withstand periods of market turmoil. By design the Index seeks to create a holistic portfolio with lower risk than the market, without taking large individual stock or sector bets. This focus has historically facilitated more stable returns over time providing resilience when market returns are more erratic, or are suffering severe downside losses.  Importantly, the objective of these strategies is not to beat the market, but rather to deliver market-like exposure with less risk.

We can observe this historically favorable trade-off when looking at the monthly returns of the Index versus the S&P 500 in different market environments. The Minimum Volatility strategy has delivered positive excess returns when the broad market has declined[5]. However, when the market posts monthly returns between 0% and 2%, the Index, on average, captured the market return. This dynamic, along with participation in up markets, has led the Index to capture 80% of the upside but only 62% of the downside of the S&P 500 since it was incepted[6]. As such, we believe a Minimum Volatility strategy can be leveraged as a core holding within a strategic allocation as an attractive way to reduce risk.

MSCI USA minimum volatility index excess monthly return vs S&P500

icon-pointer.svgMore on min-vol in Emerging markets.

Position for resilience

As demonstrated above, Minimum Volatility strategies have historically provided resilience through out-performance in down markets, helping investors remain invested during periods of market stress and uncertainty. Remember, humans experience the woes of losses more severely than the joys of gains (termed “loss aversion”), making lower downside capture an effective way to keep investors in the market and on track with their long-term goals. Thus, more stable equity allocations to Minimum Volatility strategies such as USMV can be a powerful core holding within portfolios. With continual political and economic concerns potentially fueling higher volatility, investors would be prudent to consider deploying a Minimum Volatility strategy within their portfolios.

Holly Framsted, CFA, is the Head of US Factor ETFs within BlackRock’s ETF and Index Investment Group and is a regular contributor to The Blog.

[1] Source: BlackRock, as of 12/31/2018

[2] Source: BlackRock, as of 12/31/2018

[3]Source: CBOE, CBOE VIX Historical data from 1/2/1992 – 12/31/2018

[4]Source: CBOE, CBOE VIX Historical data from 1/2/1992 – 12/31/2018

[5] Broad market is defined as the S&P 500 Index.

[6] Source: Morningstar Direct from 6/2/2008–11/30/2018

Carefully consider the Funds’ investment objectives, risk factors, and charges and expenses before investing. This and other information can be found in the Funds’ prospectuses or, if available, the summary prospectuses which may be obtained by visiting www.iShares.com or www.blackrock.com. Read the prospectus carefully before investing.

Investing involves risks, including possible loss of principal.

The iShares Minimum Volatility Funds may experience more than minimum volatility as there is no guarantee that the underlying index’s strategy of seeking to lower volatility will be successful.

This material represents an assessment of the market environment as of the date indicated; is subject to change; and is not intended to be a forecast of future events or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding the funds or any issuer or security in particular. This document contains general information only and does not take into account an individual’s financial circumstances. This information should not be relied upon as a primary basis for an investment decision. Rather, an assessment should be made as to whether the information is appropriate in individual circumstances and consideration should be given to talking to a financial advisor before making an investment decision.

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of February 2019 and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and non-proprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this post is at the sole discretion of the reader. Past performance is no guarantee of future results. Index performance is shown for illustrative purposes only. You cannot invest directly in an index.

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