Low Volatility Investing – Why haven’t I heard of this?
By Greg Major, Financial Advisor
This article was published in The West Australian, Secure Your Future insert, on 21 August 2017
Unless you are in the upper echelon of well-read investors, you may not have heard of low volatility investing. While not uncommon, it is not considered mainstream either. For those who follow passive or index strategies, it falls under that broad and somewhat slippery umbrella term “smart-beta”. However, there are also active versions of low volatility investing that use the same basic principles.
Low volatility investing is a method of building (typically) an equity portfolio which is designed to deliver more return per unit of risk than you would receive in a typical capital weighted benchmark portfolio, the latter example being a portfolio linked to the ASX200. Therefore it is a departure from the common approach of building a portfolio which is essentially based around the normal market indices. For those familiar with the lingo, this can result in a portfolio with a high “tracking error” (a measure that indicates how closely a portfolio follows the index to which it is benchmarked), but they are designed to deliver a superior “Sharpe Ratio” (a measure for calculating risk-adjusted return).
That just means they deviate quite a bit from the traditional index in terms of performance but overall, they aim to deliver high returns per unit of risk. This is useful if your goal is to take equity market risk but with reduced risk relative to return, rather than necessarily following the overall market ups and downs step for step.
Another advantage often cited with these portfolio types is that they deliver asymmetric performance. This means they tend to capture a greater share of the upside performance of market movements than the downside performance, something that is appealing to preserving capital in a downswing.
BlackRock has reported the MSCI All Country MinVol Index (the low volatility index) shows 70% of the upside capture of the MSCI All Country Index and only -42% of the downside capture[1]. This is great since the upside outweighs the downside and this could be very effective in sideways or down markets. However it also demonstrates the potential disadvantage of this investing approach, in that you may be giving up some of the upside movement along the way, which may not suit all investors, particularly in strong up-trending markets.
The last point to note is that this approach, in my opinion, doesn’t substitute for diversification of your portfolio. Whilst it may work to reduce volatility and create asymmetry in your equities allocation, appropriate allocation to other asset classes, including defensives, it still going to be the most appropriate way for most investors to ensure a long term balance or risk and return that can be tailored to their specific risk appetite. If in doubt, contact us to speak to a financial advisor.
Greg Major is an authorised representative and credit representative of AMP Financial Planning. Blueprint Planning Pty Ltd (ABN 78 097 264 554), trading as Blueprint Wealth, is an authorised representative and credit representative of AMP Financial Planning, Australian Financial Services Licensee and Australian Credit Licensee (AFSL / ACL 232 706).
This article contains information that is general in nature. It does not take into account the objectives, financial situation or needs of any particular person. You need to consider your financial situation and needs before making any decisions based on this information.
[1] BlackRock Investment Management (Australia) Limited. “Minimum Volatility Investing: Strategies to Reduce Risk in Today’s Markets.” 11/11/2016
