Managing Risks Beyond Volatility

Abstract

Minimum volatility strategies enjoy broad support in the academic literature and have been applied extensively by institutional investors to reduce portfolio volatility. In this article, the authors discuss how such strategies can adapt to address risks beyond price volatility. Specifically, concentration, sustainability, and crowding risks could be mitigated using appropriate but simple optimization constraints. However, adding a diversification constraint increased exposure to residual volatility and had a negative impact on risk reduction and risk-adjusted performance. In contrast, to help manage environmental, social, and governance (ESG) risks, adding a significant sustainability constraint had only a small effect on the risk reduction properties. Finally, introducing constraints on the value exposure ensured the market-relative valuations of the strategy remained attractive for only a small increase in realized volatility. The authors show that simple constraints could be used effectively in minimum volatility strategies to manage risks beyond volatility.