Low-risk strategies are often improperly associated with investments in securities with a high level of debt and an abnormal interest rate sensitivity. Therefore, investors are worried of a substantial underperformance of those strategies should interest rates rise from their current low or even negative level. Among other sources , our Research Note 01/2017  addresses this topic: the average leverage of our Minimum Variance (MV) portfolio is not higher than the one of the market and, most importantly, the predominating factor is not interest rate sensitivity but rather economic growth- respectively stock market dynamic.
In this blog post, we investigate whether there is a systematic out- or underperformance of OLZ MV portfolios against the corresponding market-capitalization indexes during certain stock market and interest rate regimes. Our study covers the period from 31.05.2002 until 31.10.2018 for the following four regions: USA, Eurozone, Japan and Australia. Market and interest rate regimes are classified using the Harding-Pagan algorithm .
The Effect of Market Conditions
We start by analyzing the average monthly excess return of the MV strategy conditional to market regimes (see figure 1). In market downturns, the MV strategy outperforms substantially across all equity universes, while it underperforms during bull market regimes. This behavior is a well-known characteristic of low-risk strategies, and it results, on average andover the long term,in an outperformance.
Figure 1: Outperformance of Minimum Variance by Equity Market Regimes (Up- vs. Down-Market):