Getting Paid to Lower Your Risk

We completed the attached research paper earlier this year, prior to the onset of the tremendous volatility due to the Coronavirus crisis. We realize that advisors will likely ask if the findings still hold true in the wake of this volatility. The answer is yes. Low volatility equities, particularly when controlled for sector bets and combined with the quality factor, helped investors navigate the steep market sell-off and subsequent partial recovery. This success was due to the greater participation in or capture of positive markets compared to negative ones. Low volatility equities compounded this up-down capture asymmetry, leading to risk reduction and improvements in returns even in upward trending markets, thus suggesting low volatility equities warrant serious consideration as a core equity strategy. We have seen this asymmetry at play not only during these past couple of months, but over the longer run as well. Indeed, looking at our own strategies, these combined characteristics have provided a significantly improved Sharpe Ratio versus the market. This improvement has come not only from a reduction in risk, which is to be expected, but also from an improvement in return during a bull market period that ended March 11 of this year. Combined, these improved metrics gave investors a lot of flexibility in deploying low volatility equities, as discussed in our paper.

© Northern Trust Asset Management

© Northern Trust

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