If history is any guide, we should be closer to the end than the beginning of a bull market in equities – the largest source of risk for most portfolios. This is particularly the case as the extreme measures used to stabilize the world economy as the throes of the Global Financial Crisis are winding down, while political risk is on the rise, including in major developed economies. Mitigating that risk over the next 10 years may be essential, but doing so without sacrificing the need for capital growth is the challenge. That’s the rationale behind defensive equity investing.
Case for Defensive Equity Investing
Most investors require the returns associated with equity allocations despite the resulting increased portfolio volatility. Even with a historically long equity bull market, many DB plans remain under pressure to close funding gaps. Portfolio returns are challenged to keep up with growing liabilities. DC plan participants face a similar dilemma. Today’s low interest rates and increasing life expectancy present challenges for all types of investors.
It’s no wonder we’ve seen surging interest in defensive equity strategies. An equity strategy that can deliver less risk and the same or more return changes the value proposition of equities – typically the largest contributor to overall portfolio volatility. Regardless of your investment objectives, adding defensive equity strategies has the potential to unlock several benefits (Figure 1).
Funding in a Low Return Environment
Whether you’re paying out benefits from a DB plan or helping DC plan participants generate retirement income, implementing defensive equity strategies potentially improves funding status, and that may be especially true in flat or down equity markets.
We’ve been in a 10-year equity bull market, but what if the next 10 years don’t look as rosy? What if they look like the first 10 years of the millennium instead? Imagine drawing down from an equity allocation between 2000 and 2009 when the annualized return for MSCI World Index was just 2.8%.
During this period, a simple 4% withdrawal rate adjusted for inflation each year by 3% would have cut a cap-weighted portfolio value by over 25%. In contrast, values for a hypothetical global low volatility portfolio actually increase by over 25% (Figure 2). Market drawdowns reduce the capital upon which to compound returns and that can have a significant impact on funding status for pension plans or individual investors.
Learn More
The current market environment is driving many investors to take a hard look at defensive equity investing. That’s why we’re offering a fresh look at the topic: How to Make Equity Allocations More Resilient.
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