Balancing risk and return expectations over the business cycle

Balancing risk and return expectations over the business cycle

by Pininvest Analysis

US Large Cap Selection for Peace of Mind on

  • constituents
  • 25.9% 1y performance
  • 14.8% volatility
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With the launch of a number of low volatility funds, the fact higher risk may not after all – and over time – be rewarded with higher performance, as the theory suggests, has been given publicity

Considering the 500 largest market capitalizations, past performance bears no clear relation to risk exposure.  At sector level, as of mid-January 2018, over the past 12 months

  • Technology, Industrial Goods and Services, with respective performances of 48%, 42%, and 41%, are well ahead with among the lowest volatilities (9% on average for Ind. Goods and Services, 12% for Technology)
  • With the exception of the more volatile Basic Materials, Energy and Transportation, the other sectors seem  equally ‘risky’ with volatilities moving in a band of 7 to 12,5% but none of these sectors has achieved performances comparable to the 3 leaders

However, a single-minded focus on low volatility equities would be inconclusive as demonstrated by strikingly similar performances of the global 500 portfolio (+22% for 12 months Jan '17 - Jan' 18), of the unit portfolio of the 50 lowest volatility shares (+21,5%) and of the 100 lowest volatility shares (+25%)

Because a few sectors will be overweight in low volatility selections, with Utilities and Finance counting for 50¨% of our 100 low volatility asset selection, their sensitivity to the business cycle will determine the actual outcome over time, as the business cycle runs its course – and not over just one year

Under the assumption an investor might seek stability without having to align his or her expectations with the full cycle, we create – as a reference dated mid-January 2018 – a portfolio based on the lowest volatilities and the lowest Maximum Drawdown (smallest continuous price drop observed over the past 12 months), resulting in a fairly balanced sector combination in the large cap universe

This portfolio selection will be reviewed every quarter