Why low volatility strategies can be better for retirement

When withdrawing money from an investment portfolio in retirement, the ‘sequence of returns’ risk becomes a major concern. This risk refers to the order in which investment returns occur, especially in the early stages of retirement when the portfolio is most vulnerable due to its size.
Below we outline the risks relating to the retirement phase and explain how these risks can be mitigated by using a strategy such as the Quoniam Global MinRisk Fund.

Key advantages of Low Volatility equities over traditional equities

1. Reduced sequence risk

• In retirement, you sell assets to generate income.
• If the market drops early in retirement and you sell during those downturns, you lock in losses and reduce the capital base, making it harder to recover even when markets rebound.
• A minimum volatility strategy generally experiences smaller drawdowns during market declines.
• This means you are less likely to sell at a significant loss, which helps your portfolio last longer.

2. Volatility drag and compounding math

• Higher volatility means greater price fluctuations, both up and down.
• Returns are geometrically compounded, not arithmetically. While the long-term average return may be similar, volatility can erode compounded returns (i.e. the final wealth). A portfolio that loses 20% and then gains 20% isn’t back to even – it’s still down.
• This effect is called volatility drag and is amplified when withdrawing money. A smoother return reduces the impact of ‘selling low,’ helping to preserve capital more effectively.
• By reducing volatility, Min Vol strategies help minimise this drag and improve the odds of maintaining purchasing power.

The following chart illustrates the volatility drag using data from the US stock market¹.  The stocks in the index were ranked by volatility and then split into ten portfolios.  In the first seven portfolios with volatility below 20%, we can see that returns do not improve significantly as volatility increases. There is a slight improvement in returns between 20 % and 25 %, but the stocks with the highest volatility perform the worst. 

Figure 1: Ten US stock market portfolios (Lo = low beta/volatility, Hi = high beta/volatility)

3. Behavioural benefits

• Minimum volatility strategies often lead to less stress and better investor behaviour.
• Retirees may be less tempted to panic during market downturns if their portfolio is more stable, reducing the likelihood of making emotional decisions such as selling all their equities.

Conclusion

A minimum volatility strategy is not necessarily better simply because of its potential to outperform the market. It is better because it aims to lose less during market downturns, offers more predictable returns and reduces the impact of sequence risk when funds are regularly withdrawn. Over time, this can result in a higher likelihood of sustaining retirement income than with a traditional, higher-volatility, market-cap-weighted equity strategy.
At Quoniam Asset Management, we manage successful strategies utilising this minimum volatility approach in global, European and emerging market regions. If you would like more information on this approach and how it can be implemented as part of a retirement solution, please contact us.