Building timeless portfolios

Minimum volatility strategies are one way to seek more equity stability, which may help investors stay in the markets over the long run.

Severe volatility tests even the most disciplined investors. The longest-ever bull market for U.S. stocks came to a halt this year as COVID-19 worries gripped financial markets around the globe. Stock volatility surged, the S&P 500 plunged more than 30% and equities have been sold indiscriminately regardless of their region or sector.

Many are left with questions swirling about money saved for retirement, a new home or a grandchild’s college education. It’s only human to experience the pain of losses more severely than the joys of gains. In behavioral finance, this concept is known as “loss aversion.” Faced with stiff declines, it’s easy to consider retreating from risky assets such as stocks and moving toward havens such as cash. But this approach comes with a potential cost as well: History shows that investors who try to time the market frequently exit stocks after a large loss, only to miss the potential rebound.

While market swings can be tough to swallow, we believe investors have a better chance to achieve financial goals if they stick to a long-term plan. From a behavioral perspective, lower volatility is easier for most investors to stomach – and stay in the market. Minimum volatility strategies such as the iShares Edge MSCI Min Vol USA ETF (USMV) have also delivered market-like returns over time, even with a focus on risk reduction (see below).

It’s all about the math of loss.

Losing less can lead to winning more

Take a hypothetical investor who starts out with $1. Their timing was unlucky, and the market drops by 50%. To recoup the lost 50 cents and get back to $1, stock prices now need to double—a large hole from which to dig out of. Limiting downside can help prevent investors from falling so far in the first place, and needing less to recover when markets turn around.

 

Minimum volatility strategies have mitigated losses

Minimum volatility portfolios maintain exposures to stocks, so investors still have the ability to participate in rallies. The difference is that they invest in stocks that individually or holistically may exhibit historically lower risk, all while diversifying across sectors. As a result, these portfolios have tended to fall less than the market during negative periods (i.e. the downside capture) while still participating during positive periods (i.e. the upside capture). Over time, minimum volatility strategies have delivered lower risk with returns similar to the broader market.

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Minimum volatility: A strategy that has worked in various markets

The potential benefits of minimum volatility strategies aren’t limited to U.S. large-cap stocks; they apply to other developed markets, as well as emerging markets and U.S. small caps. As the chart below shows, these strategies have demonstrated better performance than their broad market counterparts over the long term, with considerably less risk. To be clear, these strategies seek to reduce risk, not provide excess returns. In other words, international and small cap minimum volatility strategies allow investors to build global portfolios while aiming for risk reduction, including markets they might otherwise find too risky.

No one can predict when markets will become bumpy, but investors can be better prepared to endure the ride. Minimum volatility stock strategies have delivered market-like returns with reduced volatility over full market cycles, acting as a precise tool to build resiliency into a strategic equity allocation.

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. Joseph Nelesen, Ph.D., Director and Priya Panse, Associate contributed to this post.

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.

There can be no assurance that performance will be enhanced or risk will be reduced for funds that seek to provide exposure to certain quantitative investment characteristics (“factors”).  Exposure to such investment factors may detract from performance in some market environments, perhaps for extended periods. In such circumstances, a fund may seek to maintain exposure to the targeted investment factors and not adjust to target different factors, which could result in losses. 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.

Diversification and asset allocation may not protect against market risk or loss of principal.

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.

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