Weathering the storm with minimum volatility ETFs

The longest-ever bull market for U.S. stocks ended abruptly 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.

Recent market turbulence has once again put minimum volatility strategies to the test. Since markets started selling off, the MSCI Australia IMI Select Minimum Volatility and MSCI World Minimum Volatility Indices (the indices that iShares Edge MSCI Australia Minimum Volatility ETF (MVOL) and iShares World Minimum Volatility ETF (WVOL seek to track respectively) have outperformed the market. In line with long run performance, the indices have delivered market-like returns with less risk.

US Min Vol and S&P 500 - Cumulative Returns and Trailing 1-Year Volatility

 

MSCI Australia IMI Select Minimum Volatility and S&P/ASX 200 Data 1/1/2020-30/04/2020. BlackRock, Morningstar. 1Y volatility equals the annualised standard deviation of the relative price change for the 253 most recent trading days closing price, expressed as a percentage. Standard deviation measures how dispersed returns are around the average. A higher standard deviation indicates that returns are spread out over a larger range of values and thus, more volatile. Index performance is for illustrative purposes only. Index performance does not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index. Past performance does not guarantee future results.

Cumulative Return and Average Volatility

 

MSCI World Minimum Volatility and MSCI World Data 1/1/2020-30/04/2020. BlackRock, Morningstar. 1Y volatility equals the annualised standard deviation of the relative price change for the 253 most recent trading days closing price, expressed as a percentage.

A longer-term view reveals similar performance through previous market gyrations, creating improvement in risk-adjusted returns for the minimum volatility investor.

Cumulative return and Average Volaitlity

 

Data 12/10/2016-30/04/2020. BlackRock, Morningstar. Average volatility is the average trailing 254 day volatility for MSCI Australia IMI Select Min Vol Index and S&P/ASX  200 Total Return index. 254 day volatility equals the annualised standard deviation of the relative price change for the 254most recent trading days closing price, expressed as a percentage. Index performance is for illustrative purposes only. Index performance does not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index. Past performance does not guarantee future results.

Time in the market, not timing the markets

Severe volatility tests even the most disciplined investors. Questions are swirling about money saved for retirement, a new home or a grandchild’s college education. 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 subsequent rebound.

While market swings can be tough to swallow, investors have a better chance of achieving their financial goals if they stick to a long-term plan. From a behavioral perspective, lower volatility is easier for investors to stomach.

Minimum volatility portfolios seek to track indexes made up of stocks, so investors still have the ability to participate in stock rallies. The difference is that minimum volatility portfolios contain stocks that exhibit historically lower risk, and may diversify across sectors. As a result, these portfolios have tended to fall less than the market during a downturn while still capturing upside during a recovery. Over time, minimum volatility strategies have delivered lower risk with returns similar to the broader market.

Minimum volatility strategies have mitigated losses

Upside/Downside Capture

Upside/Downside Capture

 

Source: BlackRock, Morningstar. Based on monthly index returns 12/10/2016 - 30/04/2020. MSCI Australia IMI Select Min Vol to MSCI Australia and S&P/ASX 200 for Australia, MSCI World Minimum Volatility to MSCI World for Global. Index performance is for illustrative purposes only. Index performance does not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index. Past performance does not guarantee future results. Index performance does not represent actual iShares Fund performance. For actual fund performance, please visit www.iShares.com or www.blackrock.com.

Losing less can lead to winning more

Take a hypothetical of an investor who starts out with $100 in the stock market. Their timing was unlucky, and the market drops by 50%. To recoup $50 and get back to $100, stocks 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.

After a drop, a steeper climb

After a drop, a steeper climb

 

For illustrative purposes only

A relevant strategy for markets under stress

The magnitude of recent market volatility has almost no precedent in modern history.

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.” However, the stresses of the market often lead to investors doing the wrong thing at the wrong time. This hurts investors even more because they are not only locking in a loss, they are likely to miss out on potential future stock market gains which often come quickly after large losses.

Growth of $100 - S&P 500 Over 30 Years

Growth of $100 - S&P 500 Over 30 Years

 

Data 02/04/1990-01/04/2020. S&P/ASX 200 Total Return Index, Morningstar. Index performance is for illustrative purposes only. Index performance does not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index. Past performance does not guarantee future results.

Min Vol: A strategy that has worked in various markets

The potential benefits of minimum volatility strategies apply in developed and emerging markets. In both regions they have demonstrated better performance compared to their broad market counterparts over the long term. International minimum volatility strategies allow investors to build global portfolios with targeted risk reduction, including regions which investors think are otherwise “too risky.”

Min Vol Risk/Return

Min Vol Risk/Return

 

Source: BlackRock, Morningstar. Annualised return and standard deviations from 01/11/2016–30/04/2020. Start date chosen to reflect the first full month following the inception of MVOL and WVOL, the funds that seek to track the MSCI Australia IMI Select Min Vol and MSCI World Min Vol indexes, respectively. Index performance does not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index. Past performance does not guarantee future results.

No one can predict when markets will become bumpy, but investors can be better prepared to endure the ride. One lesson from the recent turbulence: Minimum volatility stock strategies have the potential to deliver better performance through challenging times and help investors stay invested.