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Don't Overreact

Trying to time the market may do more long-term damage to your portfolio than any short-term market decline.

Taking a low volatility approach to uncertain markets

The recent shock to economic activity created by the spread of COVID-19, flaring tensions between Turkey and Syria in the Middle East, and the upcoming US presidential election are a reminder that equity prices can be volatile, and risk is ever present.   In fact, the CBOE Volatility Index (VIX)1, a measure of expected equity volatility for the S&P 500 Index, finished the week ending February 28, 2020 at 40.11%. That high a level of volatility has not been seen since the summer of 2015, when Chinese stocks fell 40% and the Chinese yuan was devalued because of concerns about poor economic growth2.  A VIX close over 40 is unusual and has occurred in only seven periods since 1990, but it does happen.  Timing and trading the impact of black swan events and geopolitical uncertainty are difficult endeavors for even the most seasoned financial professionals.  Investors looking to navigate a world of risk and manage the ups and downs of equity investing may want to consider a low volatility strategy.

What’s a low volatility strategy?

As the name implies, low volatility strategies focus on stocks with a history of lower volatility than their peers. For example, the S&P 500 Low Volatility Index3 invests in the 100 stocks out of the S&P 500 Index that had the lowest realized volatility over the past 12 months.

We see two main benefits to this approach:

  • Upside participation. Because they invest in stocks, low volatility strategies have the potential to rise along with the equity markets (though they tend not to gain as much as higher volatility stocks). For example, between April 30, 2011, and August 31, 2019, the S&P 500 Low Volatility Index captured 76% of the upside of the S&P 500 Index.4
  • Downside risk mitigation. At the same time, low volatility strategies have tended to lose less when equity markets fall. From April 30, 2011, to August 31, 2019, the S&P 500 Low Volatility Index captured just 42% of the downside of the S&P 500 Index.4

It’s this second feature that may be particularly attractive after the type of volatility we’ve seen this year. Below, we illustrate how a low volatility approach has outperformed during significant downturns in the large-cap, mid-cap, and small-cap markets. During particularly weak equity markets (as defined by a 5% drop or greater in the benchmark indexes for each cap size), the low volatility indexes have averaged excess returns of 4.29%, 2.98%, and 2.71% over the large-cap, mid-cap, and small-cap benchmarks, respectively.

Low volatility indexes have outperformed their benchmark indexes during market downturns
Low volatility indexes have outperformed their benchmark indexes during market downturns
Bloomberg, L.P. as of Aug. 31, 2019, analyzing the period between Jan. 31, 2013, and Aug. 31, 2019. Market downturns are defined as a 5% drop in the benchmark indexes, which are the S&P 500 Index (large caps), S&P MidCap 400 Index (mid caps) and S&P SmallCap 600 Index (small caps) The low volatility indexes are: S&P 500® Low Volatility Index (large caps), S&P MidCap 400 Low Volatility Index (mid caps), and S&P SmallCap 600® Low Volatility Index (small caps).

Important Information

  • The opinions expressed are those of the authors, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.
  • This does not constitute a recommendation of any investment strategy or product for a particular investor. Investors should consult a financial advisor/financial consultant before making any investment decisions. Invesco does not provide tax advice. The tax information contained herein is general and is not exhaustive by nature. Federal and state tax laws are complex and constantly changing. Investors should always consult their own legal or tax professional for information concerning their individual situation. The opinions expressed are those of the authors, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.
  • 1 The CSI 300 is a capitalization-weighted stock market index, designed to replicate the performance of top 300 stocks traded in the Shanghai and Shenzhen stock exchanges, declined 40% from June 12 to Oct 2 2015. Seven periods = 1998, 2001, 2002, 2008, 2010, 2011, and 2020. Bloomberg LP
  • 2 The CBOE Volatility Index® (VIX®) is a key measure of market expectations of near-term volatility conveyed by S&P 500 stock index option prices. VIX is the ticker symbol for the Chicago Board Options Exchange (CBOE) Volatility Index, which shows the market’s expectation of 30-day volatility.
  • 3 The S&P 500® Low Volatility Index consists of the 100 stocks from the S&P 500® Index with the lowest realized volatility over the past 12 months.
  • 4 The S&P 500® Index is an unmanaged index considered representative of the US stock market.
  • 5 The S&P MidCap 400® Low Volatility Index consists of 80 out of 400 medium-capitalization range companies from the S&P MidCap 400® Index with the lowest realized volatility over the past 12 months.
  • 6 The S&P MidCap 400® Index is an unmanaged index considered representative of mid-sized US companies.
  • 7 The S&P SmallCap 600® Low Volatility Index consists of 120 out of 600 small-capitalization range securities from the S&P SmallCap 600® Index with the lowest realized volatility over the past 12 months.
  • 8 The S&P SmallCap 600® Index is a market-value weighted index that consists of 600 small-cap US stocks chosen for market size, liquidity and industry group representation.
  • 9 There is no guarantee that low-volatility stocks will provide low volatility.
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