Minimum volatility strategies in a post-Brexit world

Brexit  kicked market volatility into high gear. The S&P/TSX Composite Index lost over 3% within two days after the United Kingdom’s vote to leave the European Union, as Bloomberg data shows. By week’s end, the index had rallied back to where it began before the vote, with plenty of zigzagging since.

With Brexit adding yet another layer of global economic uncertainty, investors are understandably on edge. How do I protect my capital? Where can I find growth amid heightened risk? Truth be told, we are sometimes our own worst enemy. Unsettled by uncertainties and racked by emotions, many of us too often sell at the wrong time — when equities fall — and are left out of the market when it rebounds.

Brexit is a good example. The market’s beating after the United Kingdom’s leave decision was soon followed by a sharp rally. Many investors that had run for the exits missed that rebound. What could help in avoiding a premature market exit?

Consider stepping away from the sell button

To begin with, predicting short-term market movements can be a fool’s errand. Rather than trying to time market rallies to make up for investment losses, investors may want to consider minimum volatility funds. These funds seek to reduce risk during periods of high market volatility, like Brexit, and in the past, they have delivered similar long-run returns when you look at a full market cycle, according to Bloomberg data. It’s easier to stay put and not run for the exits when you are skirting the worst of a market’s downturn, and instead focus on your long-term investment objectives.

Consider a long-term view

Brexit certainly put minimum volatility strategies to the test. But they did what they were designed to do — reduced risk, according to data from Bloomberg. However, minimum volatility funds may be used as long-term investments, so the more important question is this: What was their downside versus broad indexes over longer periods? Here too, minimum volatility strategies lost less than the relative broad market.

Historically, minimum volatility strategies have declined less than the broad indexes during market downtowns, but they also have risen less during rallies. A closer look shows that these funds have captured (considerably) less downside  and  participated in most of the upside. Given that, some are tempted to just hold minimum volatility funds during times of greater market volatility.

But predicting such turns is very hard and most investors struggle to get  both decisions right — that is, when to get out, and when to get back in. According to Bloomberg data, many investors sold near the bottom on June 27, and missed the rebound — which is exactly what minimum volatility strategies are designed to help investors avoid. These strategies are intended as long-term strategies as their full potential benefits have tended to be realized over a full market cycle.

Min vol strategies as core holdings

Because of their potential longer-term benefits, it’s worth considering minimum volatility funds as core holdings. The underlying indexes for the iShares minimum volatility ETFs have constraints on sector and country exposures relative to the parent indexes, so their diversification aims to approximate that of the broad market index. Consider: iShares Edge MSCI Min Vol Canada Index ETF (XMV), iShares Edge MSCI Min Vol USA Index ETF (XMU), iShares Edge MSCI Min Vol EAFE Index ETF ( XMI ) and iShares Edge MSCI Min Vol Global Index ETF (XMW).

And more importantly, history has shown that market-moving events like Brexit are as inevitable as they are unpredictable. Seeking to reduce risk with minimum volatility strategies and having them as the core part of a portfolio could make sense.

Dr. Andrew Ang, Head of Factor Based Investing at BlackRock, wrote this post for   The Blog .