Turning Less into More: Revisiting Equity Risk in a Volatile Year

During this period of economic uncertainty and market stress, investors may be surprised to discover how a strategy targeting stocks that lose less in a downturn can beat the market over time.

Most investors implicitly understand the concept of risk. The framework was famously laid out in the capital asset pricing model (CAPM) of the 1960s, which explained expected return as a function of both firm-specific risk and an asset’s sensitivity to the broader market. Fundamentally, however, it’s grounded in a simple concept: investors expect to be compensated for assuming more risk. If risk had no payoff, we’d all just keep our assets in cash and call it a day.

Relative vs. Absolute Risk in a Choppy Market

Too often, investment managers are consumed with relative risk—tracking their performance against a market-cap-weighted benchmark index. This can conflict with what really matters to investors—absolute performance and how well an investment addresses long-term financial goals.

The issue becomes especially thorny during bouts of market volatility. And lately, there’s been plenty of it.

Amid stubborn inflation and economic slowing this year, the stock market posted its worst first half since 1970, with the S&P 500 retreating by more than 20%. While stocks have recovered some of their losses in the third quarter, market choppiness has continued, as investors digest lowered earnings guidance and the prospects of additional monetary tightening.

This is where the rubber meets the road. It’s one thing to talk about sticking to a long-term investment plan but quite another to sit tight as your portfolio takes a drubbing.