The volatility seen during the Global Financial Crisis (GFC) in 2008 broke the calm that was present in financial markets from 2004 to early 2007. Most asset classes experienced significant pullbacks, markets became volatile, and the correlation between asset classes increased significantly. Portfolio construction based on the backward-looking correlation model failed, as the expected diversification benefit was eliminated precisely when it was needed the most.
In the aftermath of the GFC, institutional market participants with long-term investment horizons have responded with aversion to this volatility by considering a number of risk control strategies. The risk control strategies adjust market exposure in inverse relation to risk to target a stable level of volatility in all market environments. For institutional market participants with long-standing liabilities, which can range from defined benefit plans to variable annuities offered at insurance companies, a risk control strategy may provide a smoother path of asset returns (see Exhibit 1) and could more closely align the performance of the institution’s assets to the characteristics of its liabilities.
S&P Dow Jones Indices has developed a risk control framework through a series of risk control indices, which seek to measure various underlying equity- or futures-based indices at set risk levels. S&P Dow Jones Indices’ risk control indices feature:
- Globally accepted, independent underlying indices like the S&P 500, S&P 500 Low Volatility, and S&P 500 Dividend Aristocrats®;
- Transparent methodology based on the underlying index’s historical volatility;
- Measurements of risk, based on volatility, to help market participants control risk at a predefined level; and
- Utilization of the same constituents as the underlying index.
S&P Dow Jones Indices has created a suite of risk control indices based on a large number of equity and thematic indices, along with the S&P GSCI® and the other commodity indices in its series (see the Appendix for a complete list).