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Did defensive strategies get the job done in the recent downturn?

By Mark Barnes, managing director, head of US research

Recent market turbulence has awakened memories of the painful side of stock volatility. It has also revived interest in defensive strategies that can provide long-term downside protection without sacrificing upside participation. But not all defensive strategies are created alike—they have distinct objectives and have produced very different return patterns over time. The December meltdown and subsequent snapback offer a live test case of this point.

In our recent research paper, we compare three popular defensive approaches using back-tested FTSE Russell index data since September 2003: Minimum Variance (Min Var), Low Volatility Factor (LVF), and Equal Risk Contribution (ERC). They pursue very different goals:

  • Min Var seeks to minimize the portfolio volatility, while maintaining sufficient diversification
  • LVF explicitly targets consistent exposure to the (low) Volatility factor
  • ERC portfolios are built so that each stock contributes equally to the overall portfolio volatility, with the aim of avoiding concentration risk

To achieve these goals, each strategy employs its own implementation rules. As our research shows, even small differences in these methodologies can yield major differences in risk exposures and performance, especially over the short run.

This was clearly the case in the most recent bout of market volatility. As expected, all three hypothetical defensive portfolios fell less than the benchmark (the FTSE Developed Index) in the Q4 downturn and rose less in the January rebound, outperforming for the full four-month span. Excess returns were highest for Min Var (at +2.2%), followed by LVF (+1.0%) and ERC (+0.85%).

Exhibit 1. Total returns (%)

Table 2 provides a more granular look at the sources of excess returns.1 Most of Min Var’s and ERC’s excess returns came from country and industry exposures, while very little came from factor exposure. By contrast, three-fourths of LVF’s excess return came from factor exposure.

Table 2: Attribution summary of sources of excess returns (%) - October 2018 to January 2019

This pattern makes sense given that both Min Var and ERC’s construction methodology revolve around portfolio risk, which acts to diversify country and industry exposures.

Factor exposures can make a big difference in performance (Table 3). LVF benefited from its large (and specifically targeted) exposure to (low) Volatility factor, which outperformed the benchmark over this period. While Min Var is usually overweight (low) Volatility, its exposure was neutral during this period, hindering performance. The same goes for ERC, which also had negative exposure to (low) Volatility. Another important factor was Momentum, which had lagged the benchmark during the period. Min Var and ERC’s negative exposures to Momentum contributed to their outperformance. 

Table 3: Select factor attribution details - October 2018 to January 2019


In our research paper, we delved into how these strategies behaved during previous market shocks, notably the Global Financial Crisis, the Lehman Collapse, the European Credit Crisis and the China Growth Scare of 2015. Although all approaches provided meaningful downside protection during these episodes, they did so in ways particular to their makeup.   

These analyses underscore the effectiveness of defensive strategies to perform as expected during times of heightened volatility. As critical, however, it reinforces how their differing objectives result in different exposures and, thus, performance outcomes. It’s important for investors to understand these differences when choosing the approach that can best address their long-term investment needs.


[1] The attributed effects do not match the actual excess returns exactly because of compounding effects.


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