Insights


Balancing Risk with a Diversifying Low Volatility Exposure

  • Despite the dominance of growth stocks in the past decade, low volatility exposure has provided strong relative risk-adjusted performance, especially during down market months.
  • Investors who expect the reflation trade to continue on positive earnings and inflation expectations can look to complement a portfolio with downside protection.
  • In addition to strong low volatility exposure, the index tracked by our low volatility ETF aims to offer diversification* from large cap (size) and a strong yield following the August 2021 rebalance.

Growth-dominant sectors (e.g. technology, communication services and consumer discretionary) and the FAANG stocks in particular have led the S&P 500 Index to its current all-time highs. Despite these relatively high volatility companies leading the market on a nominal basis, low volatility stocks have still provided strong relative risk-adjusted performance since the launch of the S&P Low Volatility Index in April 2011, as evidenced by the strong Sharpe ratio of 1.06 (see Figure 1). 

Figure 1: Risk Return Comparison 

1-espresso-low-volatility

We see this result because the relationship between excess performance of the S&P Low Volatility Index and the nominal performance of the S&P 500 is negative (see Figure 2). This means that low volatility stocks tend to outperform, on average, in markets where the S&P 500 trades lower. The relationship creates an opportunity for investors to build a degree of protection into portfolios through diversification.

Figure 2: Monthly US Low Volatility Active Return vs. Market Return

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The asymmetric relationship of relative returns is not the only diversification opportunity for investors in low volatility. Following the August 2021 rebalance, the S&P Low Volatility Index offers significantly low size exposure (i.e. stocks with smaller market capitalisation) and significantly high dividend yield exposure (see Figure 3).

Figure 3: FaCS Active Exposure Comparison (vs. S&P® 500 Index)

3-espresso-low-volatility

How to play this theme

Within US equities, we believe investors focused on medium to longer-term volatility may benefit from the diversification of a strategic investment to low volatility. SPDR® offers a suite of low volatility strategies that follow a simple yet effective methodology. In one trade, investors can introduce a defensive posture to their equity allocations using the SPDR® S&P® 500 Low Volatility UCITS ETF or a similar exposure in eurozone or global equities. To learn more about this ETF, and to view performance history, please follow visit the fund page.

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