Risk is not rewarded by higher returns in the equity market

By Brian Kirk, Jyske Capital and Claus Grøn Therp, Jyske Capital

This article reviews low-risk as an equity investment strategy. The purpose is to highlight the benefits of the strategy compared to investing in a global market portfolio with a focus on the reasons behind the existence of the anomaly. The first section of the article reviews low-risk as an investment strategy and section two is a discussion of whether it is a real anomaly. Sections three and four describe advantages and disadvantages of the strategy whereas sections five to seven focus on the reasons why risk is not rewarded in the equity market.


Equity markets have in recent years been characterised by large drawdowns illustrated by the IT bubble in 2000 and the financial crisis in 2008. Investors may not expect a fall of 50% in their portfolios but such movements occur from time to time. For instance the S&P 500 index declined by more than 50% from its peak in October 2007 to the bottom in March 2009, cf. Chart 1. Likewise, the global equity market represented by MSCI AC World shed more than 40% alone in 20081 . Such declines may be disastrous for a pension fund or for investors who are close to retirement.

The large drawdowns have make investors reassess the risk in their equity portfolios. Many investors have recognised that they cannot handle the volatility in the equity market and seek better protection of their capital without sacrificing long-term returns relative to capitalization-weighted indices. Investors have increasingly been focusing on the benefits of low-risk strategies in the wake of the financial crisis. One of the benefits being that such strategies win by typically not losing as much as the general equity market in a situation with plunging equity prices. An investor experiencing a return of 30% followed by a loss of 30% will end up having larger assets (minus 9%2) than an investor who experiences a return of 40% followed by a loss of 40% (minus 16%3). A low-risk strategy will therefore be beneficiary during a multi-period consideration where the compounding effect becomes visible. In this context, it is worthy of note that drawdowns of more than 20% have been a recurring event in the equity market. For instance the US equity market have on average seen drawdowns of at least 20% every sixth year since 1950, cf. Chart 1.