After the market convulsions in 2022 – double-digit losses for bonds and equities, supply chain disruptions caused by the war in Ukraine, and interest rate rises - last year brought a turnaround in equity markets. Driven by risk taking and a handful of stocks, the rally led to positive double-digit performance in global markets, but it produced relative headwinds for many types of investors, including those that employ the low volatility style.

This is according to the recent TDAM Low Volatility Investing: Year in Review and Look Ahead article, which unpacks last year's low volatility environment and offers reflections on what investors should keep in mind this year.

Risk-on rallying types of environments like 2023 are challenging for low volatility strategies, which primarily invest in stable non-cyclical companies. Low volatility strategies are designed take advantage of the low volatility anomaly and are constructed to have less risk than that of a capitalization-weighted benchmark without sacrificing long-term returns. As a result, low volatility strategies tend to lag in strong upward moving markets, and they lag even more so when those markets are fueled by increased risk taking. Over the long-term investing cycle, low volatility strategies have typically added much of their relative performance in adverse equity markets.

Investors may be tempted to take advantage of the recent stock market rebound in the hope that it will continue. However, the phenomenon of a meteoric increase in market concentration in a handful of volatile and expensive securities, which is behind this recent surge, is the same phenomenon that makes markets extremely vulnerable. This same phenomenon took place in 2020 and ended in the double-digit market declines of 2022. Unlike 2020 though, today interest rates are significantly higher and their definitive impact remains to be seen.

This is why building a more diversified portfolio, staying away from the excesses of capitalization-weighted indices, and being attentive to the valuation and quality of the securities purchased are all measures that are even more essential today than they were a year ago.

For more detail, read the full article.

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