Lower-risk strategies for stocks

We summarize three types of lower-risk strategy: low-volatility, low-beta and minimum variance.

Low-volatility

In a low-volatility strategy, an investor selects stocks that have less volatile returns than the market, as measured by standard deviation. If the market has an average return of 5% and a standard deviation of 15%, this means that about two-thirds of the time, returns will fall within a range of +20% to -10% — one standard deviation above and below the average return.

Low-volatility stocks are typically less affected by the ups and downs of consumer and business spending. Examples include sectors such as consumer staples and utilities. Since these companies have relatively stable revenue and earnings, their stock prices tend to be less volatile than the market's.

Low-beta

In a low-beta strategy, an investor selects stocks that have a lower beta than the market. Beta measures the extent to which a stock's returns move with the market. Low-beta stocks have a beta of less than 1, while high-beta stocks have a beta of more than 1:

• A low-beta stock with a beta of 0.5 is expected to move 0.5x as much as the market, both up and down
• A high-beta stock with a beta of 1.5 is expected to move 1.5x as much as the market, both up and down

Low-volatility vs low-beta

It sounds like low-beta stocks would also be low-volatility stocks — and there can be quite a lot of overlap between these two strategies. Let's consider some examples where beta and volatility could be different:

• Low-beta, high-volatility: A utility company would typically be low-beta but its earnings could become more volatile due to regulatory changes or natural disasters
• High-beta, low-volatility: A technology company would typically be high-beta but its earnings could become less volatile due to subscription-based revenue

Investors typically calculate beta and volatility over periods of several years, so as not to overreact to short-term movements. Beta can be a slower-moving measure than volatility — the type of companies that are less correlated with the market tend not to change dramatically over time.

Minimum variance

In a minimum variance strategy, an investor selects stocks to minimize portfolio variance. As an example:

• Company A makes ice cream. The company does a lot of business in the summer but not much in other seasons.
• Company B makes parkas. The company does a lot of business in the winter but not much in other seasons.

Each company by itself might be quite volatile but the pair of stocks might be less volatile than the market when combined in a portfolio. This strategy is more complex than the previous two, since it depends on interactions between groups of stocks in a portfolio, which may change over time.

These lower-risk strategies are not completely separate. For example, some funds that are described as low-volatility can also include minimum variance.

We now compare the performance of lower-risk strategies in bull and bear markets in North America.¹

Bull markets

For a bull market, we consider the 10-year period ending March 31, 2025. The market had its ups and downs during this period, including the pandemic crash of 2020 and the tech plunge of 2022. Yet overall the market was in a bullish trend, particularly in the United States.

In Canada, the low-beta strategy outperformed on every measure. Particularly notable was the downside capture ratio.² This shows that in periods when the market was down, the low-beta strategy captured 56% of the downside, while the market captured 102% of the downside.³ In this period, high-beta plays like energy and mining mostly did not do well, which helped low-beta strategies outperform.

In the United States, the low-beta strategy underperformed, although with two points in its favour —a lower standard deviation of returns and a lower downside capture ratio. In this period, low-beta strategies couldn't keep up with the tech-fueled boom of the broader market.

Bear markets with quick recovery

For bear markets, we consider two recent examples: the pandemic crash of 2020 and the tech plunge of 2022. These are quite different examples. The year 2020 was a crash that affected the entire market and saw a rapid recovery through huge monetary and fiscal stimulus. In contrast, 2022 was a crash for the U.S. tech sector but not even a correction for the Canadian market.

In Canada, the result was a mixed bag, with low-beta losing against the market in 2020 but winning in 2022 with a smaller loss.

In the United States, the result was far more extreme, with low-beta losing against the market by over 13% in 2020, but winning by over 20% in 2022. Low-beta couldn't compete with the market in the stimulus-fueled recovery of 2020 but held up very solidly in the tech plunge of 2022.

We conclude with some implications of using lower-risk strategies in a portfolio:

Lower-risk strategies became popular after the two stock market crashes of the 2000s. Key examples of lower-risk strategies are low-volatility, low-beta and minimum variance.

We've seen that lower-risk strategies have tended to reduce losses during corrections or crashes in the stock market, compared to holding a market portfolio.

We've also seen that the returns of lower-risk strategies can be higher or lower than market returns, depending on the situation: 

• Recent 10-year bull market: Lower-risk strategies have a mixed record, having outperformed in Canada but underperformed in the United States
• Bear markets with quick recoveries: Lower-risk strategies underperformed in the pandemic crash of 2020 but outperformed in the tech plunge of 2022
• Bear markets with gradual recoveries: Lower-risk strategies have tended to shine in lengthy recoveries. Examples include the bear market of 1973-74 and the dot-com crash of 2000-02.

Lower-risk strategies can play different roles in a portfolio, including helping investors stay invested during periods of volatility, supporting portfolio withdrawals and complementing active or higher-risk strategies. Investors should also be aware of the risks and limitations of lower-risk strategies, including that they may underperform in sharp recoveries, introduce sector biases and trade at higher valuations.

Performance in this section is based on the following funds: Canadian low-beta (ZLB), Canadian market (XIC), U.S. low-beta (ZLU) and U.S. market (ZSP). Returns for 10-year periods are annualized. Data from Morningstar.

¹ Performance in this section is based on the following funds: Canadian low-beta (ZLB), Canadian market (XIC), U.S. low-beta (ZLU) and U.S. market (ZSP). Returns for 10-year periods are annualized. Data from Morningstar.

² For downside capture, lower is better. If the market crashes, do you want to capture all of that move (100% downside capture) or half of that move (50% downside capture)?

³ Normally the market would capture 100% of the upside and downside, since upside and downside are measured relative to the market. However, in these examples, upside and downside captures are not exactly 100%, because of a difference between the benchmark indexes used by Morningstar and the market indexes tracked by the funds.