By Wes Crill, PhD, Senior Investment Director and Vice President, Dimensional
Investors who want to reduce the volatility of their stock portfolios may turn to low-volatility strategies. These approaches often choose stocks in large part based on historical volatility measures with the belief that low volatility is a persistent characteristic. The expectation is dulled equity exposure, losing less than the broad market when stocks fall, but also gaining less when stocks are up.
Of course, investors looking to dampen overall portfolio volatility don’t need to resort to novel equity strategies—this is precisely the role played by bonds in many an asset allocation. And a balanced portfolio composed of traditional stock and bond strategies has historically managed this tradeoff more reliably than low-volatility strategies.
Since 1990, a 70/30 mix of global stocks and bonds has had a standard deviation of returns of 10.9%, which is about seven-tenths as high as a 100% global stock allocation, at 15.3%. Global low-volatility stocks similarly reduced volatility over the long haul (10.7% standard deviation), but the proportion of volatility reduction over rolling periods fluctuated enormously compared to the 70/30 approach. The low-volatility dampening effect appears like that of a trampoline when someone else is bouncing on it.
Past performance is not a guarantee of future results. Global Low Volatility represented by the MSCI All Country World Minimum Volatility Index (net div.). Global stock market represented by the MSCI All Country World Index (net div.). Global bonds represented by the Bloomberg Global Aggregate Bond Index (hedged to USD). 70/30 mix rebalanced to target weights each month. 70/30 mix selected to match the historical standard deviation of the low volatility index. Indices are not available for direct investment; therefore, their performance does not reflect the expenses associated with the management of an actual portfolio.