How do you know if defensive equity investing would work in your equity portfolio? Every portfolio is unique, of course. Perhaps your stable of equity managers wouldn’t work with a defensive equity strategy. It’s a reasonable concern, so we devised a way to understand the impact that defensive equity might have on a variety of multi-manager portfolios.
To demonstrate the case, we created a simple experiment. We used actual strategy performance data from eVestment to create a three-manager equity portfolio and analyzed its performance with and without a hypothetical defensive equity strategy.
The Experiment
We started by randomly selecting and combining three global large cap managers with 15 years of history. We gave each manager a third of the allocation, rebalancing the overall portfolio annually over 15 years through the end of 2018. To understand the impact of adding a defensive equity strategy to the equity portfolio, we then randomly replaced one of the managers with a hypothetical global low volatility or variable beta portfolio. We evaluated their results by calculating the difference in annualized excess return, standard deviation, Sharpe ratio, and downside capture between the two portfolios (one with defensive equity as 1/3 of the allocation, and one without). The entire procedure was repeated 10,000 times.
“Adding a defensive equity allocation to our thousands of multi-manager models tends to result in material improvements to their risk-return profile.”
The Results
Adding a hypothetical defensive equity allocation to our thousands of multi-manager models tends to result in material improvements to their risk-return profile (Figures 1 and 2). Specifically, adding a hypothetical low volatility or variable beta strategy results in average improvements in excess return of 0.47% and 0.72%, respectively. On the risk side of the equation, the low volatility strategy reduced standard deviation by 2.43% and downside capture by 17.4%, on average, with corresponding reductions of 1.52% and 10.9% for variable beta. In terms of efficiency, the Sharpe ratio improved by at least 0.1 on average for both strategies.
Is 1/3 the Right Allocation?
Diversifying your equity line up with defensive equity strategies might seem compelling, but is the 1/3 allocation a reasonable substitution for you? How much of your equity portfolio should you allocate to defensive equity strategies? And how will you distinguish between the varieties of available strategies? You can investigate answers to these questions and more by downloading our paper entitled, “Evaluating and Implementing Defensive Equity Strategies.”
The information expressed herein is subject to change based on market and other conditions. The views presented are for general informational purposes only and are not intended as investment advice, as an offer or solicitation of an offer to sell or buy, or as an endorsement, recommendation, or sponsorship of any company, security, advisory service, or fund nor do they purport to address the financial objectives or specific investment needs of any individual reader, investor, or organization. This information should not be used as the sole basis for investment decisions. All content is presented by the date(s) published or indicated only, and may be superseded by subsequent market events or other reasons. Past performance is no guarantee of future results. Investing involves risk, including possible loss of principal and fluctuation of value. Hypothetical performance results presented are for illustrative purposes only. Hypothetical performance is not real and has many inherent limitations. It does not reflect the results or risks associated with actual trading or the actual performance of any portfolio and has been prepared with the benefit of hindsight. Therefore, there is no guarantee that an actual portfolio would have achieved the results shown. In fact, there will be differences between hypothetical and actual results. No investor should assume that future performance will be profitable, or equal to the results shown. Hypothetical results do not reflect the deduction of advisory fees and other expenses incurred in the management of a portfolio.