Investor Knowledge
November 14 2023

The De-risking Benefits of Low Vol Equities

5 min read

When it comes to reducing equity risk on a standalone basis, as well as total portfolio risk in a balanced portfolio, low volatility equities – i.e., the stocks of non-cyclical companies with stable earnings whose prices aren't volatile - can play a strategic role. Investing in low volatility stocks can be an effective way for investors to de-risk their portfolios while maintaining equity exposure, even in the presence of other correlated, low-risk assets.

By substituting low volatility equities for capitalization-weighted equities (i.e., broad-based stock indices weighted by market capitalization), in whole or in part, investors can potentially achieve comparable returns over a full investment cycle with a significant reduction in total portfolio risk – a phenomenon that tends to be persistent across market, volatility and correlation regimes.

This is the core argument of a new in-depth article by TD Asset Management Inc. called De-risking Portfolios with Low Volatility Equities.

One benefit of low vol equities is that they can potentially help when diversification fails. The traditional 60/40 portfolio – which includes a 60% allocation to stocks and a 40% allocation to bonds with the aim of balancing the growth potential of stocks over the long run with the defensive properties of bonds – is built on the premise that there is a persistent negative correlation between bonds and equities. When equities go up, bonds go down, and vice versa.

But when that relationship breaks down, as it did in 2022, so do the purported benefits of diversification. The 2022 experience is a reminder that while diversifying across asset classes is necessary to reduce risk, it may not always be sufficient.

Another de-risking property of low vol equities is that they can help weather market crashes. As a standalone strategy, low volatility equities have proved remarkably resilient, consistently lowering risk and downside participation across a variety of market regimes. Low volatility equities outperformed other equity styles during the worst crises of the last quarter century.

Yet another risk-reducing property of low volatility equities is that they free up room in investors' risk budget, allowing them to hold more equities or other return-seeking assets. The article demonstrates this by examining two classic 60/40 portfolios, one using capitalization-weighted equities and the other low volatility equities.

For more detail, read the full article.

The information contained herein is for information purposes only. The information has been drawn from sources believed to be reliable. The information does not provide financial, legal, tax or investment advice. Particular investment, tax or trading strategies should be evaluated relative to each individual's objectives and risk tolerance.

This material is not an offer to any person in any jurisdiction where unlawful or unauthorized. These materials have not been reviewed by and are not registered with any securities or other regulatory authority in jurisdictions where we operate.

Any general discussion or opinions contained within these materials regarding securities or market conditions represent our view or the view of the source cited. Unless otherwise indicated, such view is as of the date noted and is subject to change. Information about the portfolio holdings, asset allocation or diversification is historical and is subject to change.

This document may contain forward-looking statements (“FLS”). FLS reflect current expectations and projections about future events and/or outcomes based on data currently available. Such expectations and projections may be incorrect in the future as events which were not anticipated or considered in their formulation may occur and lead to results that differ materially from those expressed or implied. FLS are not guarantees of future performance and reliance on FLS should be avoided.

TD Global Investment Solutions represents TD Asset Management Inc. ("TDAM") and Epoch Investment Partners, Inc. ("TD Epoch"). TDAM and TD Epoch are affiliates and wholly-owned subsidiaries of The Toronto-Dominion Bank.

® The TD logo and other TD trademarks are the property of The Toronto-Dominion Bank or its subsidiaries.