Weathering the storm with minimum volatility

BlackRock |May 8, 2020

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 USA Minimum Volatility Index (the index that the iShares MSCI Min Vol USA Index ETF, ticker XMU seeks to track) has outperformed the market. The cumulative effect of its better upside and downside capture was 1.6%1 of outperformance versus the S&P 500, with significantly reduced risk.

US Min Vol and S&P 500 Index - cumulative returns and trailing 1-year volatility

Chart: US min vol and S&P 500 Index - cumulative returns and trailing 1-year volatility

MSCI USA Minimum Volatility and S&P 500 Index Data 1/1/2020-3/20/2020. MSCI, Bloomberg. 1Y volatility equals the annualized standard deviation of the relative price change for the 260 most 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.

A longer-term view reveals similar performance through previous market gyrations, creating improvement in risk-adjusted returns for the minimum volatility investor. The longer-term chart below reveals similar cumulative outperformance and lower average trailing volatility of the MSCI USA Minimum Volatility Index versus the S&P 500 Index from June 2, 2008 to March 20, 2020.

Cumulative Return and Average Volatility

Chart: Cumulative return and average volatility

Data 6/2/08-3/20/20. MSCI, Bloomberg. Average volatility is the average trailing 260 day volatility for MSCI USA Minimum Volatility Index and S&P 500 Total Return index. 260 day volatility equals the annualized standard deviation of the relative price change for the 260 most 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: the chart below shows that investors who try to time the market frequently exit stocks after a large loss, only to miss the subsequent rebound. It illustrates the growth of $100 in the S&P 500 Index over 30 years when staying invested vs. missing the 10 best days.

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

Chart: Growth of $100 - S&P 500 over 30 years

Data 3/20/1990-3/20/2020. S&P 500 Total Return Index (USD), Bloomberg. 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.

While market swings can be tough to swallow, study after study shows that 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 investors to stomach.

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.

Minimum volatility upside/downside capture ratios

Chart: Minimum volatility upside/downside capture ratios

Source: Morningstar. Based on monthly index returns 12/1/2009 – 12/31/2019. MSCI Canada Min Vol to MSCI Canada IMI for Canada, MSCI USA Min Vol (USD) to MSCI USA (USD) for USA, MSCI EAFE Min Vol (USD) to MSCI EAFE (USD) for Developed, and MSCI EM Min Vol (USD) to MSCI EM for EM (USD), MSCI ACWI Minimum Volatility (USD) to MSCI ACWI (USD) 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.ca.

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.

After a drop, a steeper climb

A portfolio can win more over time by losing less in down markets

Chart: A portfolio can win more over time by losing less in down markets.

For illustrative purposes only

Min Vol: 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. These strategies have demonstrated similar performance to 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, minimum volatility strategies allow investors to build global portfolios while aiming for risk reduction, including markets (ex. Emerging 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. 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.

Min Vol ETF Performance

Geo Type Ticker Return (%) Excess Return (%) Risk (%) Risk Reduction (%) Name
Canada Min Vol XMV 6.5 0.9 12.5 11.8 iShares MSCI Min Vol Canada Index ETF
Broad Market XIC 5.7 14.2 iShares Core S&P/TSX Capped Composite Index ETF
USA Min Vol XMU 15.2 -0.7 14.1 6.7 iShares MSCI Min Vol USA Index ETF
Broad Market XUS 15.9 15.1 iShares Core S&P 500 Index ETF
International Developed Min Vol XMI 8.2 1.5 11.7 15.5 iShares MSCI Min Vol EAFE Index ETF
Broad Market XEF 6.7 13.8 iShares Core MSCI EAFE IMI Index ETF
Emerging Markets Min Vol XMM 3.5 -0.8 13.0 21.7 iShares MSCI Min Vol Emerging Markets Index ETF 
Broad Market XEC 4.3 16.6 iShares Core MSCI Emerging Markets IMI Index ETF

Source: Bloomberg. Return: annualized returns between the common inception of 04/19/2013 and 04/24/2020. Risk:standard deviations (annualized) based on weekly total returns of the same period. Past performance does not guarantee future results. For standardized performance, please click on the fund tickers above.

Holly Framsted, CFA
U.S. Head of Factor ETFs