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The longest-ever bull market for U.S. stocks ended abruptly this year as COVID-19 worries gripped financial markets around the globe. Stock volatility surged, the S&P 500 plunged more than 30% and equities have been sold indiscriminately regardless of their region or sector.

Recent market turbulence has once again put minimum volatility strategies to the test. Since markets started selling off, the MSCI USA Minimum Volatility Index (the index that the iShares US Minimum Volatility ETF, ticker USMV seeks to track) has outperformed the market. In line with its long run performance, the index has delivered market-like returns with less risk.

US Min Vol and S&P 500 - Cumulative Returns and Trailing 1-Year Volatility

Line graph showing 2020 cumulative outperformance and lower average trailing volatility of the MSCI USA Minimum Volatility Index versus the S&P 500 Index from 1/1/2020-3/20/2020

MSCI USA Minimum Volatility and S&P 500 Index Data 1/1/2020-3/20/2020. MSCI, Bloomberg. 1Y volatility equals the annualized standard deviation of the relative price change for the 260 most recent trading days closing price, expressed as a percentage. Standard deviation measures how dispersed returns are around the average. A higher standard deviation indicates that returns are spread out over a larger range of values and thus, more volatile. Index performance is for illustrative purposes only. Index performance does not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index. Past performance does not guarantee future results.

A longer-term view reveals similar performance through previous market gyrations, creating improvement in risk-adjusted returns for the minimum volatility investor.

Cumulative Return and Average Volatility

Line graph showing longer-term chart revealing similar cumulative outperformance and lower average trailing volatility of the MSCI USA Minimum Volatility Index versus the S&P 500 Index from 5/30/2008-3/20/2020

Data 6/2/08-3/20/20. MSCI, Bloomberg. Average volatility is the average trailing 260 day volatility for MSCI USA Minimum Volatility Index and S&P 500 Total Return index. 260 day volatility equals the annualized standard deviation of the relative price change for the 260 most recent trading days closing price, expressed as a percentage. Index performance is for illustrative purposes only. Index performance does not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index. Past performance does not guarantee future results.

Time in the market, not timing the markets

Severe volatility tests even the most disciplined investors. Questions are swirling about money saved for retirement, a new home or a grandchild’s college education. Faced with stiff declines, it’s easy to consider retreating from risky assets such as stocks and moving toward havens such as cash. But this approach comes with a potential cost as well: History shows that investors who try to time the market frequently exit stocks after a large loss, only to miss the subsequent rebound.

While market swings can be tough to swallow, study after study shows that investors have a better chance to achieve financial goals if they stick to a long-term plan. From a behavioral perspective, lower volatility is easier for investors to stomach.

Minimum volatility portfolios seek to track indexes made up of stocks, so investors still have the ability to participate in stock rallies. The difference is that minimum volatility portfolios contain stocks that exhibit historically lower risk, and may diversify across sectors. As a result, these portfolios have tended to fall less than the market during a downturn while still capturing upside during a recovery. Over time, minimum volatility strategies have delivered lower risk with returns similar to the broader market.

Minimum volatility strategies have mitigated losses

Upside/Downside Capture

Bar graphs displaying the upside and downside capture of various minimum volatility indexes relative to their respective broader markets

Source: Morningstar. Based on monthly index returns 12/1/2009 – 12/31/2019. MSCI USA Min Vol to MSCI USA for USA, MSCI ACWI Minimum Volatility to MSCI ACWI for Global, MSCI EAFE Min Vol to MSCI EAFE for Developed, and MSCI EM Min Vol to MSCI EM for EM, Index performance is for illustrative purposes only. Index performance does not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index. Past performance does not guarantee future results. Index performance does not represent actual iShares Fund performance. For actual fund performance, please visit www.iShares.com or www.blackrock.com.

Losing less can lead to winning more

Take a hypothetical of an investor who starts out with $100 in the stock market. Their timing was unlucky, and the market drops by 50%. To recoup $50 and get back to $100, stocks now need to double—a large hole from which to dig out of. Limiting downside can help prevent investors from falling so far in the first place.

After a drop, a steeper climb

Chart displaying an example of a market drop and the growth required to make up for the drop to recover losses.

For illustrative purposes only

A relevant strategy for markets under stress

The magnitude of recent market volatility has almost no precedent in modern history.

It’s only human to experience the pain of losses more severely than the joys of gains. In behavioral finance, this concept is known as “loss aversion.” However, the stresses of the market often lead to investors doing the wrong thing at the wrong time. This hurts investors even more because they are not only locking in a loss, they are likely to miss out on potential future stock market gains which often come quickly after large losses.

Growth of $100 - S&P 500 Over 30 Years

Line graph that compares the growth of $100 in the S&P over 30 years when staying invested vs missing the 10 best days

Data 3/20/1990-3/20/2020. S&P 500 Total Return Index, Bloomberg. Index performance is for illustrative purposes only. Index performance does not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index. Past performance does not guarantee future results.

Min Vol: A strategy that has worked in various markets

The potential benefits of minimum volatility strategies apply in developed and emerging markets. In both regions they have demonstrated better performance compared to their broad market counterparts over the long term. International minimum volatility strategies allow investors to build global portfolios with targeted risk reduction, including regions which investors think are otherwise “too risky.”

Min Vol Risk/Return

Chart showing how minimum volatility indexes have reduced risk versus their broad market counterparts

Source: Morningstar. Annualized return and standard deviations from 11/1/2011–3/20/2020. Start date chosen to reflect the first full month following the inception of USMV, ACWV, EFAV and EEMV, the funds that seek to track the MSCI USA Min Vol, MSCI ACWI Min Vol, MSCI EAFE Min Vol and MSCI EM Min Vol indexes, respectively. In the case of MSCI USA Min Vol SmCap and the MSCI USA Small Cap indexes, data is from 10/1/2016–3/20/2020. This start date reflects the first full month following the inception of SMMV which seeks to track the MSCI USA Min Vol SmCap index. Index performance does not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index. Past performance does not guarantee future results.

No one can predict when markets will become bumpy, but investors can be better prepared to endure the ride. One lesson from the recent turbulence: Minimum volatility stock strategies have the potential to deliver better performance through challenging times and help investors stay invested.

Joseph Nelesen and Priya Panse contributed to this article.

Holly Framsted, CFA
U.S. Head of Factor ETFs
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