Soaring stock prices thrill investors but, when equity markets fall—as they frequently do—the financial and emotional impacts can be lasting. Fortunately, by focusing on reducing downside, investors can have a smoother ride, and still achieve the equity returns they want.
Imagine a hypothetical equity portfolio designed to capture 80% of every market rally and fall only 50% as much as the market during every sell-off (Display 1). Historically, how would such a portfolio have performed over the long term?
Display 1: An Equity Portfolio with a “Smoother Ride”
You might think that this strategy would have underperformed the broad equity index, but a portfolio designed this way can indeed outperform the market. Our research shows, for example, that it would have beaten the S&P/ASX 200 by more than three percentage points between January 1990 and December 2016, with much less risk and volatility (Display 2).
Display 2: Calculated Performance of Hypothetical Low Volatility Portfolio vs. S&P/ASX 200 Index
January 1, 1990, to December 1, 2016
| S&P/ASX 200 Index | Low Volatility Portfolio* |
| Annualised Return | 9.1% | 12.3% |
| Annualised Volatility | 13.2% | 8.7% |
The reason is simple: a portfolio with reduced downside risk loses less in sell-offs, so it has less ground to make up when markets recover.
Read more The Upside of Less Downside: How Defence Can Win in Australian Equities.