1 idea for minimizing
portfolio risk

May 24, 2017
By BlackRock

Financial planning dictum will often have you bucket your investment style or risk tolerance into three categories: conservative,
moderate or aggressive.

Logic says that the most conservative investors are the most risk-averse. Analysis from BlackRock’s Portfolio Solutions team, however, uncovered an unsettling surprise.

Most portfolios riskier than broad benchmarks

Most portfolios riskier than broad benchmarks

“Of the ‘conservative’ portfolios in our database, nearly 90% were riskier than their benchmark,” reveals Patrick Nolan, the team’s portfolio strategist. The numbers for the moderate and aggressive groups were lower at 82% and 68%, respectively.

Why the disconnect? Market dynamics are partly to blame. With bonds offering low yields, for example, investors are forced into riskier corners to achieve their income goals. But Mr. Nolan also notes a lack of understanding about how the stock and bond components of a portfolio work together and react to different market events.

Sara Shores, Global Head of Smart Beta for BlackRock, agrees:

You may hold many different types of securities, but if those securities are affected by the same risks, your portfolio is probably not as diversified as you think.

— Sara Shores, Global Head of Smart Beta for BlackRock

Growth risk, she explains, figures prominently in public and private equities, high yield debt, some hedge funds and real estate. “So as economic growth slows, a portfolio overly exposed to that particular factor will see its overall return move lower, regardless of how diverse its holdings are across assets or regions.”

A closer read on risk

As markets become more complicated and intertwined, it’s important to look beyond asset class labels to the factors that are driving returns.

A simple term with big meaning, “factors” are time-tested sources of return within and across asset classes.(See table below)

While institutional investors and active managers have been using factors to build portfolios for decades, they are now widely available to individual investors through “smart beta” exchange-traded funds (ETFs).

“Smart beta ETFs seek to combine some of the benefits of rules-based index investing (low cost and tax efficiency) and active investing (targeting specific ideas) in an effort to enhance return, improve diversification and reduce risk,” Ms. Shores explains.

And by fine tuning your exposures, you can potentially reduce the unintended risks that can lead to unpleasant surprises in your portfolio.

Factors at work

Following are examples of some well-known style factors and the market environments in which they might be rewarded:

FactorsTypes of companies/stocksFavorable environments
Value Stocks with low prices relative to fundamentals Early economic cycles
Momentum Stocks with a positive price trend Trending markets and expansions
Quality Companies with strong balance sheets Late economic cycles or recessions
Minimum volatility Stocks with lower-than-average volatility Volatile, risk-averse and/or declining markets

To learn how smart beta might factor into your portfolio, speak with your financial advisor or visit ishares.com/smartbeta.

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