How a New Benchmark Adds to the Evaluation of a Defensive Equity Strategy

Abstract

Defensive equity strategies represent a useful addition to an equity allocation, but evaluating them in a typical relative risk–return framework can be awkward. In some cases, changing from a cap-weighted benchmark or supplementing it with a defensive equity index can simplify and enhance the evaluation of managers and their performance. MSCI’s Minimum Volatility Indexes are one such option, but design constraints need to be understood before incorporation. An active strategy using a Minimum Volatility Index as a benchmark can help by keeping the benefits of defensive equity—downside protection and lower overall volatility—while adding an alpha component you can more easily measure and explain.

TOPICS: Fundamental equity analysis, portfolio construction, volatility measures, risk management

Key Findings

• ▪ Defensive equity strategies represent a useful addition to an equity allocation, but evaluating them in a typical relative risk–return framework can be awkward.

• ▪ In some cases, changing from a cap-weighted benchmark or supplementing it with a defensive equity index can simplify and enhance evaluation of managers and their performance. MSCI’s Minimum Volatility Indexes are one such option, but design constraints need to be understood before incorporation.

• ▪ An active strategy using a Minimum Volatility Index as a benchmark can help by keeping the benefits of defensive equity—downside protection and lower overall volatility—while adding an alpha component you can more easily measure and explain.