Winning by not losing

Winning by not losing

While many investors invest in equities because of their potential for attractive long-term capital growth, when equity markets fall, as they often do, the timing of this fall can have a major impact on your investment balance.

Low volatility strategies are designed to help “smooth the ride”, giving equity investors the opportunity to earn meaningful investment returns while reducing the downside risk of their investment. This simply means that your investment in equities should be less volatile and when the market falls, the percentage your investment falls will be less than the market.

While investing in equities should provide strong capital growth over the long-term, the Global Financial Crisis (GFC) and COVID-19 pandemic highlight just how volatile markets can be. The graph below illustrates that over the past 30 years there have been numerous events which have caused market volatility - beyond these two large scale events. And while markets usually recover to go beyond previous highs, whether or not an investor can absorb this volatility will depend upon their risk tolerance and investment timeframe.  No-one wants to be forced to sell when markets are low.

Source: Fidelity International December 2019 Reference to specific securities should not be taken as recommendations. For illustration purposes only.

For investors approaching, or in retirement, reducing downside risk is even more important than ever. Why? Let us explain below by explaining the concept of sequencing risk. 

Sequencing risk is somewhat the opposite of dollar cost averaging.  With dollar cost averaging, you invest regularly and buy more shares when investments are down. For an investor who is accumulating assets, a negative sequence of returns early on in their investment timeframe can work to their advantage as they can buy more shares and earn capital growth over time on their investment.

In retirement however, while investors are selling shares to realise income - not buying them - they may need to do so when share prices are low. For retirees, a high proportion of negative returns in the beginning years of retirement will have a lasting negative effect and reduce the amount of income they can withdraw over their lifetime.  Low volatility equity investing is a strategy designed to address this risk.  

Winning by not losing

Low volatility equity investing is based on the premise that by losing less in down markets, investors can achieve the equity returns they seek, with lower volatility than the market. These funds invest in low-volatility stocks which typically fall less than other stocks in down markets. 

And while investors may have to forgo some upside when markets rise, the capital preserved in down markets can have a material positive impact on returns over the long term.  This is because protecting from losses, or reducing those losses, in falling markets leaves more capital to grow when markets rise again, contributing to faster recoveries and the potential to generate significant market outperformance through the power of compounding. Consider the following example which explains the asymmetric relationship between gains and losses.

An example - asymmetric relationship between gains and losses

A loss of 10% in the market requires a subsequent 11.1% gain to break even and recover the value that was initially lost.  This asymmetry increases sharply as the loss increases; a 50% loss requires a subsequent 100% gain to break even. This is because of the way the mathematics of compound interest works and is often misunderstood. 

 

Limiting the downside loss has a greater impact than participating in 100% gains of the market.

 

The asymmetric relationship between gains and losses means that limiting losses during volatile markets has a more powerful effect on long-term growth potential than achieving the same nominal positive return. 

Let’s looks at another example.  From the low point of the GFC when the MSCI World Index fell 30%, it took five years for the market to recover its losses. However, if an investor realised only 50% of the loss of the MSCI World Index and then experienced 50% of the daily gains and losses of the index thereafter, it would have taken less than two years (22 months) to recoup the market’s losses. This example shows that limiting downside loss has a bigger impact on overall long term returns than participating in 100% of the gains of the market.

Fidelity’s approach to managing low volatility funds

Many low volatility equity strategies in the market are based on quantitative historical data, which is backward looking. Fidelity’s Global Low Volatility Equity Fund uses a combination of both quantitative (backward looking) and fundamental analysis (forward looking) to assess the risk profile of a stock and build its portfolio.  

To find out more about Fidelity’s approach to low volatility investing visit the Fund page.

 

 

This document is issued by FIL Responsible Entity (Australia) Limited ABN 33 148 059 009, AFSL No. 409340 (“Fidelity Australia”). Fidelity Australia is a member of the FIL Limited group of companies commonly known as Fidelity International.

This document is intended for use by advisers and wholesale investors. Retail investors should not rely on any information in this document without first seeking advice from their financial adviser. This document has been prepared without taking into account your objectives, financial situation or needs. You should consider these matters before acting on the information.  You should also consider the relevant Product Disclosure Statements (“PDS”) for any Fidelity Australia product mentioned in this document before making any decision about whether to acquire the product. The PDS can be obtained by contacting Fidelity Australia on 1800 119 270 or by downloading it from our website at This document may include general commentary on market activity, sector trends or other broad-based economic or political conditions that should not be taken as investment advice. Information stated herein about specific securities is subject to change. Any reference to specific securities should not be taken as a recommendation to buy, sell or hold these securities. While the information contained in this document has been prepared with reasonable care, no responsibility or liability is accepted for any errors or omissions or misstatements however caused. This document is intended as general information only. The document may not be reproduced or transmitted without prior written permission of Fidelity Australia. The issuer of Fidelity’s managed investment schemes is FIL Responsible Entity (Australia) Limited ABN 33 148 059 009. Reference to ($) are in Australian dollars unless stated otherwise.

© 2022 FIL Responsible Entity (Australia) Limited. Fidelity, Fidelity International and the Fidelity International logo and F symbol are trademarks of FIL Limited.

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