Author Details

Arihant Jain

Arihant Jain

Associate, MSCI Research

Mehdi Alighanbari

Mehdi Alighanbari

Executive Director, MSCI Research

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Escaping to Equities for Yield

  • As they seek required rates of return in the low-rate environment, some investors may seek to shift a portion of their portfolio from fixed income to riskier assets such as equities.
  • Historically, equities have had higher returns, but also higher volatility, than bonds.
  • The lower volatility of a minimum-variance equity portfolio meant investors could have allocated more to equities if they used a minimum-variance portfolio rather than a market portfolio — even on a fixed risk budget.

The extended low-rate environment has made it difficult for some investors to achieve the required yield and meet their liabilities using traditional asset-allocation levels. This, arguably, has had more impact on the insurance sector, where a larger portion of portfolios have traditionally been allocated to fixed-income assets such as bonds. While some have sought to overcome this challenge with a shift toward historically higher-yielding but riskier assets such as equities, for others, equities’ higher risk has limited their ability to allocate to the asset class.

That said, the level of volatility or risk varies depending on the composition of the equity portion, including industry, region and style-factor allocations, as well as the level of concentration. A defensive equity portfolio, for instance, may offer a risk level more comparable to bonds. There are various ways to construct such a portfolio, including one built from industries with historically lower return volatility and more resilience to market downturns. But perhaps the most intuitive defensive approach is a minimum-variance portfolio. Could that have been a viable alternative?


Adding Equities to a Fixed-Income Portfolio

We start by assessing the impact of incrementally adding equities into a bond-only portfolio. Throughout this blog post we use MSCI equity and fixed-income indexes as proxies for equity and bond portfolios, respectively,1 using data from Feb. 28, 2006,2 to Dec. 31, 2020. The exhibit below shows the risk/return profile of different combinations of equities and fixed income within a global portfolio.


Risk/Return Trade-Off for Equity/Bond Combinations


Toggle the dynamic exhibit above to see the results for the U.S. All data from Feb. 28, 2006, to Dec. 31, 2020.

In both cases shown above, a larger allocation to equities meant higher historical returns, but also higher risk. Where the MSCI World Minimum Volatility Index is used as a proxy for the equity portion, we see a more attractive risk/return trade-off, which stems from overall lower historical volatility compared to the market-cap index.

To give the numbers a bit of context, working with a risk budget of 0.3 to 0.4 percentage points above the pure-bond index-based portfolio would have allowed us to substitute 10% of the MSCI Global Bond Index with the MSCI World Index, which would have resulted in a 0.4-percentage-point (around 7%) increase in annualized return. For the MSCI World Minimum Volatility Index, we could have substituted 20% of the bond portion with equity, which would have resulted in a 0.7-percentage-point (around 13%) increase in annualized return. We saw similar results from a hypothetical U.S.-focused portfolio.


Beyond Simple Risk and Return

The better risk/return characteristics of a minimum-variance equity portfolio is not surprising. Extensive previous research has demonstrated the existence of a historical low-volatility premium. Over the period of analysis, the MSCI World Minimum Volatility Index had higher returns with significantly lower volatility, compared to the MSCI World Index, resulting in higher risk-adjusted return. It should be noted that while the lower-volatility characteristics of the minimum-volatility index have been more or less consistent over any historical period, its performance relative to the MSCI World Index has varied over time.

Other dimensions of risk such as value at risk were also favorable for the MSCI World Minimum Volatility Index compared to the MSCI World Index. As a result, risk-adjusted-return measures such as the Sharpe and Calmar ratios3 were higher (i.e., better) for the minimum-volatility index.

These improved risk/return characteristics can be seen in the bond/equity combinations, as shown in the exhibit below. While a pure-bond portfolio had better risk characteristics compared to pure equity, replacing a small portion of bonds with equities had limited impact on the risk of the overall portfolio. This impact was even smaller for a minimum-volatility equity allocation.


Risk/Return Characteristics of Bond/Equity Allocations


Toggle the dynamic exhibit above to see the results for the U.S. All data from Feb. 28, 2006, to Dec. 31, 2020.


Heightened Volatility Enhanced Min Vol’s Defensive Effects

As we see in the exhibit below, the MSCI World Minimum Volatility Index displayed lower risk throughout the analysis period — even more so when equity-market volatility rose in the aftermath of the 2008 global financial crisis and at the onset of the pandemic in 2020.


Historical Volatility of Market-Cap and Minimum-Volatility Indexes


Toggle the dynamic exhibit above to see the results for the U.S.


Fewer Securities Didn’t Automatically Mean More Concentration Risk

As a result of the MSCI Minimum Volatility Index methodology, which calls for the selection of a subset of the market-cap parent index (often lower-volatility stocks) to seek the lowest possible volatility, there is the potential for increased concentration risk in these indexes compared to a parent index. Concentration risk has become more important as the weight of mega-cap stocks has increased over the past few years. We examine this risk by looking at the concentration of the MSCI World and MSCI World Minimum Volatility Indexes using effective number of constituents4 and weight of the five largest constituents.

Both measures showed an increase in the concentration of the MSCI World Index, peaking at the end of 2020. For the minimum-volatility index, however, the level of concentration was stable over time; a feature resulting from an explicit limit on the weight of each individual stock. Similar controls on sector and country weights prevented large overweights or underweights and associated risks from these factors.


Concentration of Market-Cap vs. Minimum-Volatility Indexes


Toggle the dynamic exhibit above to see the results for the U.S.


Investors Freed from Their (Overreliance on) Bonds?

A minimum-variance approach would have helped investors with lower risk budgets to shift some of their portfolio from fixed income to traditionally riskier assets such as equities. We showed that more of their assets could have been allocated to a minimum-variance equity portfolio (proxied by MSCI World Minimum Volatility Indexes) compared to a simple market-cap portfolio (proxied by the MSCI World Index). This additional allocation to equities, historically, would have improved absolute and risk-adjusted returns without busting the risk budget.



1Using past market-capitalization trends of MSCI USD, EUR and GBP Investment Grade Corporate Bond Indexes, we fixed weights at 50%, 40% and 10%, respectively, to create a global bond portfolio. We use the MSCI World Index as a proxy for a global equity portfolio.

2The starting point is chosen based on the availability of data for all the indexes used in this analysis.

3The Sharpe ratio is calculated by dividing excess return of a portfolio by its total risk. The Calmar ratio is calculated by dividing annualized return by maximum drawdown.

4The effective number of constituents is a measure of index concentration and ranges between 1 (for a single stock) and the number of stocks in the Index (for an equal-weighted index). It is calculated as the inverse of the Herfindahl-Hirschman Index (HHI).



Further Reading

Managing Portfolios in a Low-Rates Age

The MSCI Minimum Volatility Indexes: 10 Years On

Constructing Low Volatility Strategies

How Diversified Are US Equity Investors?