Defensive equity: The first five years
In the five years since the launch of the Russell 1000® Defensive Index, the defensive approach has delivered a less volatile return pattern than the broad market Russell 1000® Index. More surprisingly, it has also delivered a higher overall return.
The first five years of live return data
Defensive equity investing—i.e. focusing on less-risky stocks—has been around for decades, and in 2010 Russell Investments launched defensive and dynamic indexes to complement the existing value/growth and large cap/small cap index series.
That means there are now five full calendar years of live index performance, and performance over that period—which I analyze in more detail in a recently-published research note—paints an encouraging picture for advocates of a defensive approach.
The key findings are:
- When the market has fallen, the defensive index has fallen less quickly (capturing around 73% of the downside.) That’s what it was designed to do; these are the markets in which the low-risk mindset is supposed to provide some downside protection.
- When the market has risen, the defensive index has risen less quickly (capturing around 91% of the upside.) This, too, is what should have been expected to happen; defensive investors ought to expect their gains in a rising market to lag those of more aggressive strategies.
- Over the full five year period 2011-2015, the Russell 1000® Defensive Index delivered an annualized return of 13.5%, which was more than the broad market Russell 1000® Index’s 12.4%.
This final point—strong relative performance by the defensive index—is not, on the surface, what should be expected over a five-year period that saw double-digit broad market returns. It is, however, consistent with the back-tested previous history of the strategy; the long-term track record is one of defensive stocks outperforming. As for what the future may hold, that’s a matter of opinion, but the general view at Russell Investments remains that expressed by Mark Thurston in 2011¹, namely that it is counterintuitive to expect that higher returns to a lower-volatility index will persist.
Defensive equity in 2016: strong performance but unattractive valuation
With the dramatic start to the year, we’ve had another chance to test the effectiveness of the defensive approach at managing market losses. As of the close of February 22, 2016, the Russell 1000® Defensive Index had fallen year-to-date by 1.9%, as compared to the broad market Russell 1000® Index’s 5.0% fall².
Of course, with all strategies/factors, there are good times and bad times to make a move; defensive is no different. So I should include a quick cautionary word on the current valuation of defensive stocks. For that, I’ll turn it over to Evgenia Gvozdeva, a member of Russell Investments’ equity research team.
She says: “The relative³ valuation of defensive stocks has run up in the recent past, making them seem less attractive. We define defensiveness using two main components, quality and low volatility. Sometimes we see a divergence in valuations—today, in the US, low volatility is priced higher than the historical relative average but quality is not. Low volatility stocks, however, have a bigger impact on defensive index valuations.”