Market volatility: When defense can be the best offense  

Maxine Elliott    Catherine Yoshimoto, director, product management, FTSE Russell
27 May 2019
Categories: General Market Analysis, Investor Education, Equity Investments

Country or region: Asia Pacific (Overall)

Summary:
As market turbulence increases due to geopolitical and trade war concerns, investors look to low-volatility indices for protection. How do such defensive strategies stack up against broad market indices?


Reference URL: https://www.ftserussell.com/blog/market-volatility-when-defense-can-be-best-offense



Abstract

It would be tough to argue that low market volatility hasn’t had a good run. But between the selloff at the end of last year and the more recent turbulence triggered by trade war concerns, it would appear we could be nearing the end of this era of relative market tranquility. This presents us with another opportunity to take a closer look at our Russell US Stability Indexes®—in particular to examine how the Defensive Indexes® have weathered the spikes in market volatility over the past year.

At this time 10 years ago, global markets were still reeling from the financial crisis. Foreclosures and unemployment were rising in its aftermath, and market volatility remained at high levels after a March 2009 selloff again roiled investors. But by mid-2010 the dust had started to settle, and market volatility dipped to pre-Great Recession levels—and stayed there. The chart below tells this story, as it tracks the 12-month rolling standard deviation—a measure of volatility—of the Russell 3000® and Russell 3000 Defensive Indexes over the past 10 years.



The chart above also sheds light on another interesting story, which is the study of Russell 3000 Defensive Index volatility relative to its Russell 3000 Index counterpart. As shown, during times of heightened volatility the Defensive Index exhibited a lower standard deviation than the Russell 3000. This is consistent with its design, as the Russell 3000 Defensive Index is constructed to represent the more stable half of the Russell 3000.

Another angle to examine when comparing these two indexes is performance during periods of volatility. If we isolate the outbreak of volatility over the past year, we can see that performance divergence between the Russell 3000 Index and Russell 3000 Defensive Index was most pronounced during volatility spikes—and this set the indexes on separate and distinct performance paths.



As shown, one year ago both indexes started the period with near identical performance. However, these trajectories began to diverge during the market downturn in the fourth quarter of last year. While the Russell 3000 Defensive Index performance was impacted by the selloff, it was to a lesser degree than the Russell 3000 Index. This resulted in a larger dip in performance for the Russell 3000, and a subsequent and persistent lag relative to the Defensive Index.  

The same was true for the more recent volatility, where escalating US/China trade war tensions have again shaken the markets. For example, when stocks plummeted on May 13 of this year, the Russell 3000 lost -2.5% on that day while the Russell 3000 Defensive Index posted a -1.9% return. This is an illustration of how defensive indexes may absorb less of the impact of the turbulent markets.

Times of market volatility can be unsettling, particularly after an extended period of relative calm where it’s all too easy for investors to become complacent. But turbulent markets can also serve as a reminder for investors to take a closer look at benchmarks designed to measure historically stable portions of the market. The Russell 3000 Defensive Index is one such benchmark, and it again proved to be more stable than the broad market during periods of higher volatility, true to its design.
 


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Date of original publication:

05/24/2019


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