In the wake of the financial crisis, minimum-variance strategies quickly gained traction by capturing the attention of a risk-averse and risk-aware investment community. Minimum-variance strategies help investors defend themselves against losses during market declines and, unsurprisingly, could have proved helpful during the financial crisis.
This year the usefulness of minimum-variance strategies was put to the test when the Brexit vote sent equities across the world into a tailspin only to see them rebound strongly and then retreat again. U.S. and European equities plunged on June 24, as Britons chose to relinquish their European Union membership, surprising pollsters and analysts in the U.K. and around the world. On June 28, following a second day of declines, investors may have reconsidered the impact of the vote on global growth, as indices climbed through July 1. Concerns re-emerged in the following days, as a political crisis in the U.K. expanded, sending stocks lower for two straight sessions. By July 8, benchmark European indices showed significant losses, and U.S. indices rallied back to where they were before the vote.
Fortunately, for investors who were holding minimum-variance investments in their portfolios, these strategies did what they are designed to do: reduce drawdowns. This is shown in the table below, which compares performance of the STOXX USA 900 Minimum Variance Unconstrained index with the S&P 500 index.
Source: STOXX and Bloomberg
Minimum-variance strategies typically have smaller drawdowns and can more quickly recover losses. In fact, a large share of returns from minimum-variance strategies result from the compounding effect of smaller drawdowns. As has been said in the past, minimum variance "wins by losing less." A longer-term comparison between a minimum-variance index and a broader market index helps to illustrate the benefit of compounding.