Low volatility equity strategies aim to provide market-like returns with significantly lower risk. They accomplish this by offering downside protection and meaningful upside participation. Given their defensive nature, investors want to know whether low volatility strategies belong in a strategic asset allocation and how this allocation should be funded. In this paper, we discuss how a strategic allocation to low volatility may help an investor achieve various outcomes, and how that allocation fits into a broader portfolio.
Overview of low volatility strategies
Low volatility equity strategies typically invest in high quality, defensive companies with stable earnings and cash flows. There is extensive research showing that over full market cycles, these strategies can provide competitive risk-adjusted returns by providing downside protection along with meaningful upside participation. Notably, both research and empirical results suggest that low volatility strategies do not detract from returns in order to lower risk, suggesting they can replace existing market exposure (beta) in a portfolio without sacrificing return potential.
Applications of low volatility strategies
Since low volatility strategies offer their greatest benefits in down markets, investors have wondered how these strategies fit into an asset allocation framework. We believe low volatility strategies play different roles for different investors, but they should be an important part of every investor’s strategic asset allocation. Below, we walk through three ways in which allocating to low volatility strategies can help investors achieve desired objectives, along with suggestions for funding the allocation.