We’ve been told the same thing for 60 years: To get more return in your portfolio, you
have to take one more risk, right? That’s modern portfolio theory, proposed by Harry
Markowitz in his 1952 paper, “Portfolio Selection,” and has been generally accepted
as investment gospel.
Intuitively, this makes perfect sense. We’re always reminded that there is no “free lunch” on Wall Street, and
that the more risk you take, the greater return you should expect. However, more current academic research
has shown that, over a long period of time, investors can get higher returns with less volatility. This is known
as the low-volatility anomaly. ( S&P Down Jones, SOE, August 2012 )
Investors obligated to meet certain liabilities and commitments face a conundrum. Equities can provide the
potential for the capital appreciation that investors need to help them meet their financial obligations, but
also can have wide, varied price movements (volatility). Additionally, with interest rates at generational lows,
investors have sought equities in greater numbers. But that will undoubtedly introduce additional volatility
and downside risks to a portfolio.
WT Wealth Management embraced a change that was taking the industry by storm during the 2008-2009
market downturn and extensively researched adding equity exposure through an allocation to low-volatility
(low-vol) ETFs. Some investors may not fully appreciate this strategy’s benefits.
For many decades, investor unease with equity risk has not been addressed by traditional investing strategies
that have been focused more on following market benchmarks than on managing return volatility. Moreover,
WT Wealth Management’s low-vol emphasis provides capital preservation, which sets us apart from other
managers that do not target downside protection.
Coming out of the 2008 financial crisis, interest in low-vol strategies has grown. As the economy recovered, a
cataclysmic tilt to investments besides mutual funds occurred, and the ETF (exchange traded fund) industry
was built from the ruins of the prior bear market.
A plethora of recent academic research shows that “if you screen stocks by their volatility and take the lowest
quintile of volatile stocks over time, they will outperform the quintile of the highest volatile stocks.” ( Journal of
Portfolio Management 2014 )
A low-volatility equity strategy tries to exploit one systematic factor—price volatility—to encourage investors
to build a portfolio with the lowest volatile stocks. If you do that over a long period of time, you should be
able to get at least market-type returns without wild swings.
Investors usually pay little attention to these “unloved stocks”—stocks you know exist but rarely make the
front pages of newspapers. Traditionally these stocks have been in the consumer staple, healthcare and utility
areas, but not always. Low-volatility portfolios are trying to capture this anomaly, which can exist within other
sectors as well.
Basic math shows that it is so much easier to recover from a small loss than a large one. Wild rides are never
fun unless you are at the amusement park with the grandchildren—and even that’s debatable. The chart below
highlights that, while a 20% loss may not be any fun, it requires a 25% to break even. On the other hand, a 50%
loss requires a 100% return to get back to your starting point. It could take a decade or more to recover from a 50% loss.
Low-volatility strategies appeal to many
investors in or near retirement, since
many of them are trying to “de-risk” but
still grow their nest egg. If they can get at
least market-type returns for less risk, why
wouldn’t they do it?
At WT Wealth Management, we believe
that low-vol funds have the advantage of
allowing investors to stay committed to
the markets, where they might otherwise
have exited them early or moved more into
fixed-income investments.
The sensible option is never to take a
50% loss, and to manage your downside
with lower volatility investments. At WT
Wealth Management, we always believe
in constructing the “core” portion of the
portfolio with lower-volatility equity
strategies. For this can reduce the risk
of their portfolio without dramatically
changing the return profile.
The returns of lower-volatility strategies tend not to resemble the traditional benchmarks. If you need to
compare returns on your equity portfolio to those of an index everybody chooses as a benchmark—for
example, the Standard & Poor (S&P) 500—then you might be confused if you invest in a very, very different
strategy. Low-volatility equities would be one of those. However a low-vol strategy can sometimes handily
beat traditional benchmarks such as the S&P 500.
A popular low-vol ETF, the iShares Minimum Volatility ETF (USMV), has beaten the S&P 500 (GSPC) over
the last two years by a wide margin. As of April 4, 2016 the S&P 500 has returned 11.83%, while USMV has
returned 23.94%. SPLV, another popular low-vol ETF offered by Powershares, has returned 19.83% over that
same period of time.
With traditional mandates, most managers aim to outperform a benchmark while undertaking a similar level
of risk, but often end up taking far greater risk than the benchmark in order to beat it. Yet, in most low-vol
mandates, mangers aim to generate a return like the benchmark with 25-35% less risk. This risk-return profile
for low-volatility products resonates with many investors who cannot bear large losses.
To meet future liabilities and income commitments, investors must grow their assets at a rate high enough
to meet their obligations. While equity investing can be a strong option in these instances, many investors
are put off by the potential downside risk that large equity allocations can introduce to a portfolio. In these
circumstances, low-vol equity investing can be a compelling alternative—reducing downside-risk potential
while making little compromise on long-term returns.
At WT Wealth Management, we feel strongly about the low-volatility approach. We have built our entire
business around it. The current uncertain global macroeconomic environment is only adding urgency as
everyone remembers the destruction of wealth in 2008 and 2009. As we have hopefully demonstrated, the
risk/return payoff is compelling and offers crucial volatility discounts. We believe that strategies seeking to
diversify risks along different risk dimensions actually neutralize currency volatility, minimize trading costs,
and seek to improve returns over a full market cycle.
WT Wealth Management is a manager of Separately Managed Accounts (SMA). Past performance is no
indication of future performance. With SMA’s, performance can vary widely from investor to investor as each
portfolio is individually constructed and allocation weightings are determined based on economic and market
conditions the day the funds are invested. In a SMA you own individual ETFs and as managers we have the
freedom and flexibility to tailor the portfolio to address your personal risk tolerance and investment objectives
– thus making your account “separate” and distinct from all others we potentially managed.
An investment in the strategy is not insured or guaranteed by the Federal Deposit Insurance Corporation or
any other government agency.
Any opinions expressed are the opinions of WT Wealth Management and its associates only. Information is
neither an offer to buy or sell securities nor should it be interpreted as personal financial advice. You should
always seek out the advice of a qualified investment professional before deciding to invest. Investing in stocks,
bonds, mutual funds and ETFs carry certain specific risks and part or all of your account value can be lost.
In addition to the normal risks associated with investing, narrowly focused investments, investments in smaller
companies, sector ETF’s and investments in single countries typically exhibit higher volatility. International,
Emerging Market and Frontier Market ETFs investments may involve risk of capital loss from unfavorable
fluctuations in currency values, from differences in generally accepted accounting principles or from economic
or political instability that other nation’s experience. Emerging markets involve heightened risks related to the
same factors as well as increased volatility and lower trading volume. Bonds, bond funds and bond ETFs will
decrease in value as interest rates rise. A portion of a municipal bond fund’s income may be subject to federal
or state income taxes or the alternative minimum tax. Capital gains (short and long-term), if any, are subject
to capital gains tax.
Diversification and asset allocation may not protect against market risk or a loss in your investment.
At WT Wealth Management we strongly suggest having a personal financial plan in place before making
any investment decisions including understanding your personal risk tolerance and having clearly outlined
investment objectives.
WT Wealth Management is a registered investment adviser located in Scottsdale, AZ. WT Wealth Management
may only transact business in those states in which it is registered, or qualifies for an exemption or exclusion
from registration requirements. Any subsequent, direct communication by WT Wealth Management with a
prospective client shall be conducted by a representative that is either registered or qualifies for an exemption
or exclusion from registration in the state where the prospective client resides. For information pertaining to
the registration status of WT Wealth Management, please contact the state securities regulators for those
states in which WT Wealth Management maintains a registration filing.
A copy of WT Wealth Management’s current written disclosure statement discussing WT Wealth Management’s
business operations, services, and fees is available at the SEC’s investment adviser public information website
– www.adviserinfo.sec.gov or from WT Wealth Management upon written request. WT Wealth Management
does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness,
or relevance of any information prepared by any unaffiliated third party, whether linked to WT Wealth
Management’s web site or incorporated herein, and takes no responsibility therefor. All such information is
provided solely for convenience purposes only and all users thereof should be guided accordingly
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