Low-Volatility Investing: Balancing Total
Risk and Active Risk Considerations

Abstract

Low-volatility strategies have been shown to offer significant total risk and drawdown reduction without sacrificing returns, compared to the market. However, low-risk strategies also involve an inherent trade-off between total risk and active risk (or tracking error). Existing passive alternatives for capturing low-risk strategies emphasize total risk reduction at the expense of high and uncontrolled active risk. The article discusses a new approach for capturing abnormal risk-related payoffs at targeted active-risk levels, using a transparent, rules-based approach. This proposed approach lets investors strike a better trade-off between total risk and active risk, and implement low-volatility investing within the constraints of their active-risk budgets.