Low-risk equity investments focus not only on downside risk reduction while offering participation in the growth potential of the equity market – historically, they have also outperformed higher-volatility peers and the broad market.[1] We discuss this paradox and how to capture it via an alpha-enhanced optimised low-volatility approach.

Low-volatility investment in the current environment

With global economic uncertainties worsened by the unfamiliar threat of coronavirus, soaring global debt and a still more prolonged low interest rate environment, conservative investors in particular need to seek out reliable and meaningful returns carefully. In strategic allocation, the search for investments which deliver equity market participation and simultaneously protect the real value of wealth has become the chief focus in recent years. But many conservative equity strategies have failed to shield investors from severe losses in the COVID-19 market falls, the first big test since the global financial crisis.

Well-designed low-volatility strategies (LowVol) offer not only participation in market growth with reduced downside risk, but also outperformance historically in comparison to their higher-volatility peers and the broad market.[1] This turns conventional financial wisdom on its head, contradicting the long-held theory that higher risk must inevitably lead to higher returns. We therefore see LowVol strategies as a fundamental building block for investors.

Equity growth with reduced downside risk

The first and most fundamental attraction of LowVol strategies lies in the undeniable appeal of reduced risk. The lower the portfolio risk, the less ground the portfolio needs to recover in the event of a market downturn. It can take a portfolio a long time to recover after its value has plummeted, as can be seen in the chart below.

After the unprecedented correction during the 2008/9 financial crisis, it took five years for the MSCI Europe Index to recover. A loss of 59.1% requires a return of 144.3% from bottom for full recovery. The extent of the recovery required and the long time it can take can be very painful for investors.

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1. Baker and Haugen (2012); Razzini and Pederson (2010); Blitz and van Vliet (2007)

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This information is subject to change at any time, based upon economic, market and other considerations and should not be construed as a recommendation. Past performance is not indicative of future returns. Forecasts are based on assumptions, estimates, opinions and hypothetical models that may prove to be incorrect.

DWS International GmbH as of 07/2020
CRC 076968 (07/2020)

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