Key takeaways
- Volatility may indicate periods of market stress or uncertainty. Staying invested in a diversified asset allocation historically would have reduced the volatility and drawdowns experienced during periods of market stress when compared to equity holdings.
- During periods of elevated market stress, a diversified allocation historically offered improved returns with lower volatility compared to pure equity holdings.1
- A diversified allocation across equities and bonds historically offered reduced downturns during periods of market stress when compared to US, Developed or Emerging equities.
What is volatility?
Volatility describes how quickly market prices move over time. It’s a measure used to quantify price fluctuations, with larger movements being reflected as higher volatility.
Market volatility reflects sentiment around what is anticipated to happen next in markets. Elevated levels of volatility may signal high uncertainty, while lower volatility may reflect periods of stability. High levels of volatility often occur during periods of market or economic stress.
The VIX index shows the levels of volatility of the S&P 500 index of US equities. We show how it historically spiked during periods of market stress, when prices showed greater fluctuations.
Volatility and returns
Asset allocation is a key determinant of portfolio returns over the long run. Different asset classes have different risk and return drivers and historically have tended to perform differently in different market environments.
Equities, and in particular US equities, have outperformed most asset classes in annualized terms over the past 30 years. However, during periods of market stress, equities historically suffered greater drawdowns as well as higher volatility than other asset classes.
Returns are not annualized; periods of market stress have varying lengths.
A diversified allocation historically would have offered better risk-adjusted returns than a pure equity holding during periods of market stress, as shown the previous chart.
Looking at all periods in the chart below, we find that while a diversified allocation across equities and bonds is not as resilient as an Investment Grade bond allocation during downturns, it historically offered a combination of robust returns across all market periods and reduced downside during periods of market stress compared to equities.
Diversification through downturns
During periods of economic and geopolitical uncertainty, a diversified asset allocation historically would have reduced drawdowns in comparison to pure equity allocations.
| Market Stress | Diversified Allocation | US Equities | Developed Equities | Emerging Equities |
|---|---|---|---|---|
| Russian Default | -1.5% | -18.7% | -20.1% | -32.3% |
| 9/11 Attack | 1.9% | 0.6% | 0.1% | -8.1% |
| 2008 Crisis | -35.4% | -54.5% | -58.4% | -62.1% |
| 2010 EU Crisis | -2.0% | -14.5% | -15.6% | -11.1% |
| U.S. Downgrade | -4.2% | -12.3% | -13.1% | -15.7% |
| “Taper Tantrum” | -2.6% | -4.8% | -7.4% | -15.7% |
| China Concerns | -3.0% | -11.9% | -15.8% | -15.9% |
| Covid-19 | -9.7% | -33.8% | -34.1% | -31.3% |
| 2022 Sell off | -14.8% | -18.1% | -19.5% | -22.4% |
Returns are not annualized; periods of market stress have varying lengths.
Staying the course
In turbulent markets, the best days often occur close to the worst, making staying invested a potentially more attractive strategy than attempting to time markets. Staying the course in a diversified allocation historically would have helped to mitigate drawdowns thereby reducing the risk faced by investors compared to holding pure equity allocations.