MinRisk strategies: More stability when diversification falls short

The recent escalation in the Middle East has hit the already fragile capital markets, which are characterised by high inflation, uncertain monetary policy and rising volatility. The geopolitical tensions surrounding Iran and the possibility of further escalation pose a significant risk, not only in the short term but also over many months. Experience shows that such developments have an immediate impact on the financial markets, with rising risk premiums, volatile equity markets and an unpredictable interest rate trend being typical side effects.

Therefore, the crucial question is not only how risks can be reduced, but also how portfolios can be structured to be more robust during periods of stress.

So-called MinRisk strategies offer a possible answer to this, in both equity and fixed income.

Why diversification reaches its limits in geopolitical crises

Geopolitical conflicts present a unique challenge to markets as they affect several risk factors simultaneously. Unlike traditional economic cycles, they do not unfold in isolation, but simultaneously influence energy prices, inflation, monetary policy and investor risk appetite, often amplifying their combined effect on portfolios.

In the current environment, several of these factors are converging, which increases the likelihood that multiple sources of risk will be under pressure simultaneously. For example, an escalation in the Middle East would drive up energy prices and prolong inflation risks, as well as heightening uncertainty regarding interest rate trends. At the same time, such a shock would increase risk aversion, which could result in rising volatility and a widening of credit spreads. For investors, this means that interest rate trends become harder to predict as central banks must balance inflation against growth.

In such phases, a similar pattern often emerges:

• Equity markets react with increased volatility and, in some cases, sharp price falls.
• Credit spreads widen as investors demand higher risk premiums.
• Fixed-income markets are influenced by opposing forces: a flight to safety, and inflation concerns.

It is precisely in such phases that it becomes apparent: Diversification offers less protection than many investors expect. Correlations between risky assets rise and even supposedly defensive portfolio holdings can be affected at the same time. However, when volatility remains high, the resilience of market segments or companies with stable business models and lower earnings volatility often becomes apparent.

This is precisely where an approach that focuses not on maximum returns, but on the systematic control of risk, comes into play.

MinRisk in the equity portfolio: Systematic management of volatility and drawdowns

The Quoniam MinRisk strategy aims to minimise the impact of market drawdowns during periods of stress without compromising key sources of return. It combines risk control with targeted return signals, thereby avoiding the typical weaknesses of purely defensive approaches. The defensive nature of the portfolio is preserved, with fundamental characteristics such as valuation and sentiment improving significantly.

Minimum volatility strategies focus directly on managing a portfolio’s overall risk. Unlike traditional equity indices, which are capital-weighted and thus implicitly accept risks, a MinRisk approach is based on the active modelling of risk sources.

Stocks are considered not in isolation, but in terms of their influence on the portfolio’s overall risk. The aim is to construct a portfolio whose overall volatility is minimised, while taking into account the effects of diversification, correlations, and individual risk contributions.

This approach’s advantages become particularly clear during geopolitical crises. During such periods, correlations between equities tend to rise while the dispersion of individual stock returns increases. While traditional indices react passively to this, MinRisk portfolios actively manage risk by structurally underweighting or reducing positions with a disproportionately high risk contribution.

The key mechanism is the systematic limitation of drawdowns. Large losses do not arise from many small movements, but from a few extreme market phases. MinRisk strategies are designed to be more resilient during these phases precisely. In practice, MinRisk strategies have been shown to incur significantly lower maximum losses during periods of market stress, such as during the financial crisis, the 2020s’ pandemic-induced market correction, and the interest rate turnaround in 2022.

This pattern is also evident in the current Iran conflict environment. While global capital market-weighted indices lost around 8.5% in March, the price decline for defensive strategies was only around 6% (in USD).

An important driver of this cushioning effect in volatile times is the implicit factor allocation. MinRisk portfolios have a structural exposure to defensive factors. These include:

• Companies with stable cash flows
• Low debt
• High profitability
• Lower sensitivity to economic fluctuations

These characteristics are no coincidence and are particularly valuable during periods of geopolitical tension, as they enhance resilience to external shocks.

Another key aspect is how they respond to rising implied volatility. Rising uncertainty typically leads to an increase in implied volatility, which has direct consequences for highly volatile securities. In such environments, market dynamics shift, with risk being repriced and highly volatile securities coming under disproportionate pressure. MinRisk strategies are structurally less invested in such securities and are therefore less susceptible to these market phases.

The result is a clearly asymmetric return profile. A large proportion of positive market movements is captured (typically 80–90% upside capture), while participation in negative phases is significantly lower (often only 70–80% downside capture). Over time, this asymmetry leads to higher risk-adjusted returns.

Another often underestimated advantage is faster recovery following periods of loss. Shorter drawdowns mean that less catch-up return is required to reach the initial level again. In a market environment characterised by recurring shocks, this significantly improves the consistency of returns.

MinRisk in equities does not involve sacrificing returns for defence, but rather involves optimising the risk-return structure with a particular focus on robustness during unstable market phases.

MinRisk in credit: decoupling interest rate and spread risks

The problem presents itself differently in the credit sector, but no less clearly. Interest rate and spread risks act simultaneously and amplify uncertainty. While volatility and drawdowns are the primary concerns in the equity market, interest rate and spread risks dominate in the credit space.

Traditional credit indices fully bundle interest rate and spread risks, thereby exposing investors to both simultaneously. The often-long duration of these portfolios makes them particularly vulnerable to interest rate changes. At the same time, there is full exposure to credit spreads, which can widen rapidly during periods of stress.

This is precisely where a MinRisk strategy comes in, aiming to separate these risk components from one another.

A key lever is reducing interest rate risk through targeted duration management. Focusing on shorter maturities reduces sensitivity to interest rate changes. Additionally, an explicit interest rate hedge can be employed, for instance via short positions in government bond futures, to further lower the effective duration. The result is a portfolio whose interest rate risk is significantly lower than that of a standard benchmark, making it less vulnerable to unexpected interest rate rises.

This is particularly crucial in the current environment of high uncertainty regarding interest rate trends. Inflation risks could cause interest rates to rise further, while an economic slowdown would have the opposite effect. Reduced interest rate beta increases resilience to both scenarios.

The second key lever is the targeted management of spread risk. Rather than taking on full market exposure, the credit beta is deliberately reduced — for instance, to around 0.7. This means that the portfolio continues to participate in the prevailing market yield but reacts less strongly to widening spreads.

Spread movements are often erratic during geopolitical crises, making reduced sensitivity particularly valuable and being often non-linear. Reducing the beta acts as a shock absorber here, cushioning losses without completely sacrificing return potential.

A third, particularly important component is issuer selection. MinRisk strategies focus specifically on higher quality, thereby expanding the traditional credit approach. As well as balance sheet metrics such as the debt-to-equity ratio and the interest coverage ratio, information from the equity markets is also considered.

Metrics such as implied volatility or the value-at-risk of the shares indicate the market’s perception of a company’s uncertainty. This information is often faster and more sensitive than traditional rating adjustments. Companies with increased equity risk also tend to have a higher probability of future spread widening.

Integrating these signals creates a more comprehensive risk picture, enabling problematic issuers to be identified and avoided at an early stage.

This also generates an asymmetric return profile in the credit sector. A large proportion of the carry is captured whilst losses are reduced during periods of stress. At the same time, lower volatility leads to more stable overall returns.

An additional advantage is the reduction of tail risks. Extreme losses in the credit sector are often caused by individual problematic issuers or sectors. A risk-based selection process reduces the likelihood of exposure to such risks.

The result is stability in uncertain market phases without sacrificing key sources of return.

A common framework: risk reduction as a strategic principle

The same principle applies to all asset classes. It is the control of risk, rather than returns, that determines the stability of a portfolio.

In stable market phases, this approach is less noticeable, but in uncertain times, it becomes crucial. The reason is simple: Large losses have a disproportionately negative impact on long-term performance. For example, a loss of 30% requires a gain of more than 40% to be recouped.

MinRisk strategies address precisely this problem. They aim to systematically limit losses, reduce volatility and increase the robustness of portfolios. To achieve this, they deliberately accept a lower market beta, resulting in more stable performance across the entire cycle.

This approach is particularly relevant in the current environment. The combination of geopolitical risks, uncertain monetary policy and potentially persistent volatility suggests that markets will remain vulnerable to setbacks for some time to come.

Conclusion

Current geopolitical developments pose challenges for traditional investment approaches. Both equity and bond markets are potentially affected by heightened risks that cannot be easily mitigated through diversification within traditional indices.

MinRisk strategies are specifically designed to address these challenges. By deliberately reducing volatility, interest rate and spread risks, and maintaining a clear focus on quality, these strategies create more robust portfolios that demonstrate their strengths, particularly during periods of stress.

For investors, this does not mean sacrificing returns; rather, it involves a deliberate rebalancing away from maximum market exposure and towards more stable and predictable performance.

In an uncertain environment where risks could persist for longer than expected, this approach is becoming increasingly important.