Use low-volatility funds to manage market downturns

In an investing world often driven by fear and greed, navigating market downturns can feel like steering a fragile vessel through a storm. Low-volatility funds offer a beacon of hope, providing investors with stocks with lower price fluctuations to soften the blow of turbulent markets.

Understanding Low-Volatility Investing

Low-volatility investing is a strategy that targets equities exhibiting smaller swings in price, deliberately avoiding high-beta securities. Also known as minimum variance, managed volatility, or conservative smart beta, this approach challenges the conventional wisdom that higher risk always yields higher returns.

Academic research dating back to the 1970s revealed the low-volatility anomaly first identified, which stood in stark contrast to traditional risk-return paradigms. Notably, Fama and French (1992) demonstrated that portfolios of low-beta stocks can deliver similar or even superior returns compared to high-beta counterparts, debunking the notion that risk and reward must move in lockstep.

How Low-Volatility Funds Work

At their core, low-volatility funds select stocks based on historical measures such as standard deviation and market beta. Index providers like MSCI and S&P have developed benchmarks—such as the MSCI Minimum Volatility Index and S&P 500 Low Volatility Index—that mutual funds and ETFs can track.

Popular vehicles include USMV and SPLV, which together oversee over $40 billion in assets. These funds continuously rebalance, shedding rising-volatility names and adding steadier performers to maintain their defensive profile.

Evidence and Performance Numbers

Decades of data underscore the resilience of low-volatility strategies, both in bull and bear markets. From January 1971 through December 2023, a diversified universe of the least volatile 60% of the largest US stocks outperformed the S&P 500 Index by 226 basis points annually, with a Sharpe ratio of 0.42 versus 0.26 for the benchmark.

During the tariff-driven selloff in April 2025, low-volatility funds lost roughly 4.5%, significantly less than the broader market’s 9%+ plunge. Yet it’s crucial to remember that “low volatility” does not equate to “no volatility.” Some niche or small-cap defensive strategies still experienced double-digit declines.

Benefits of Low-Volatility Funds

Investors flock to these funds for downside protection during severe market downturns. They typically fall less in crises like the 2008 financial crash or the 2020 pandemic-driven selloff, helping preserve capital when it matters most.

Additionally, over long horizons, low-volatility portfolios can achieve higher risk-adjusted returns with less volatility, compounding wealth more consistently and reducing the emotional toll of wild market swings.

• Downside protection in sharp declines
• Steady compounding of returns
• Behavioral edge from underpriced defensive stocks

Drawbacks and Limitations

No investment is risk-free. Low-volatility funds may lag behind fast-rising bull markets due to their conservative stance, missing out on explosive rallies in high-beta sectors.

They also carry costs: frequent rebalancing can lead to higher turnover and associated fees. And during sector-specific upheavals—such as a small-cap or energy shock—even defensive strategies can experience substantial drawdowns.

• Potential underperformance in strong rallies
• Short-term declines still possible
• Rebalancing costs and turnover

Incorporating Low-Volatility Funds into Your Portfolio

Rather than a timing tool, these funds shine as a long-term strategic allocation mindset. By dedicating a portion of equity exposure to low-volatility strategies, investors can cushion drawdowns and mitigate the urge to sell at market lows.

Pairing low-volatility funds with fixed-income holdings and growth-oriented equity allocations allows for a balanced risk profile aligned with an individual’s time horizon and tolerance.

• Allocate 10–30% of equity to defensive funds
• Combine with bonds for extra stability
• Review methodology and expense ratios

Real-World Illustrations and Case Studies

Imagine an investor named Sarah, who committed 20% of her portfolio to a low-volatility ETF in 2007. When the 2008 crisis hit, that sleeve fell by only half the loss of her growth holdings, giving her the confidence to stay invested. By 2009, her overall portfolio recovered faster, thanks to steadier anchors.

Similarly, during the COVID crash, those who embraced defensive smart beta found themselves in a better emotional and financial position, avoiding panic selling and capturing the rebound more fully.

Conclusion: Embrace Stability for the Long Term

Market volatility is inevitable, but you don’t have to ride every wave alone. Low-volatility funds provide steady compounding of wealth over time, smoothing the investing journey and helping you stay the course when emotions run high.

Evaluate your portfolio today, consider a strategic allocation to defensive strategies, and partner with a trusted advisor to design a plan that weathers storms and accelerates toward your goals.