Minimum Variance: A Leg Up on Geopolitical Risk?

In this paper, we take a look at how minimum variance performed vis-à-vis its core market counterpart during nine recent geopolitical risk events. The nature of these events is that they tend to push correlations towards 1.0. This may pose a problem for minimum-variance portfolios, as they are constructed by leveraging the covariance matrix in order to build portfolios with strong systematic hedges, simultaneously going long on negatively correlated factors or (in active space) long and short positively correlated ones. In these types of crises, is their ability to significantly reduce portfolio risk vis-à-vis a core benchmark hampered? If not, what kind of outperformance can we expect in down-markets, and what are the performance costs of this insurance in up-markets?

Authors

Melissa R. Brown, CFA

Managing Director of Applied Research

Olivier d'Assier

Senior Principal, Applied Research - APAC

Christoph Schon, CFA, CIPM

Senior Principal, Applied Research

Diana R. Baechle, PhD

Director, Applied Research

Natan Borshansky

Manager, Applied Research