uploads///The Minimum Volatility Index Provides Protection When Volatility Index

Another Way to Hedge Against Volatility

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Dec. 4 2020, Updated 10:53 a.m. ET

Min vol strategies have historically performed well in volatile times. The chart below plots the VIX Index in red – a commonly used metric of market volatility. The blue bars represent the monthly performance difference between the MSCI USA Minimum Volatility Index and the S&P 500 Index. Historically the min vol index has generally out-performed the S&P 500 in months when volatility was rising. What about when volatility abates? By limiting the downside during the deepest troughs, the min vol index was better able to capitalize on a rebound.

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Market Realist – Minimum volatility is a good hedge against volatility.

As alluded to in the previous part, the minimum volatility funds perform well when volatility rises. The graph above paints a similar picture. The difference between the monthly returns of the MSCI USA Minimum Volatility Index (USMV) and the S&P 500 (SPY) was a whopping 6% (unannualized!) in the midst of the financial crisis in September 2008, when the volatility index (VXX)(XIV) touched 80 at one point.

The BP (BP) oil spill in 2010 and the downgrade of the US debt by S&P in 2011 also saw spikes in volatility and the monthly difference between the two indices.

Another advantage of the min vol funds is that by limiting the downside during the deepest troughs, it is well poised to capitalize on the rebound. For example, let’s say that a particular index starts a year at 100. Let’s say it losses 30% of its valuation that year, which brings it down to 70. Let’s say it gains 30% in the following year. This would take the index only to (70+(70*30/100)) which is 91.

Let’s assume that the minimum volatility-sibling of that index also started at 100, and for illustration sake, captures 50% of the upside and downside of the standard index. In the first year, it would lose only 15% of its value, bringing it down to 85. In the second year, it would gain 15%, taking it up to 97.75. Hence, it is better able to capitalize on a rebound.

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