By: Gene Walden, Senior Finance Editor February 15, 2018
Volatility will always play a part in the performance of the stock market, but you can help mitigate the volatility in your own portfolio by investing in asset allocation mutual funds.
Asset allocation funds are designed to attempt to reduce volatility by spreading assets around to several different types of investments, including a variety of equity securities, bonds and other fixed income securities.
Although diversification – with several asset groups feeding into the performance of the portfolio – does not eliminate risk, it may help reduce losses during stock market fluctuations. For instance, when the prices of small cap stocks are falling, U.S. blue chip stocks or international stocks within the portfolio may be moving up, along with bonds and other debt-related assets.
It is important to note that bonds can also be volatile, particularly in times when credit quality comes under pressure or when interest rates are changing. However, over longer terms, bonds have historically had lower volatility than stocks. The two asset classes can often be correlated in the opposite direction (when stocks go down, many bond sectors tend to rise), so while multi-asset portfolios could have lower returns over the long term than an all-equity index like the S&P 500®, a market-cap weighted index that represents the average performance of a group of 500 large-capitalization stocks, they will usually have lower volatility, too, often resulting in a smoother ride for investors.
The chart below shows the returns and standard deviation of returns (volatility) over a recent 17-year period of five different Morningstar Target Risk Indexes that represent various levels of diversification (with a mix of assets that may include stocks, bonds and other types of investments). The baseline is represented by the S&P 500, which shows a return level of roughly 5% and a standard deviation of around 15%. The Morningstar Conservative Target Risk Index had about the same return with dramatically less volatility, while the other indexes were somewhat more volatile than the Conservative Index, but had better returns. All five indexes had better returns and lower volatility than the S&P 500 Index.
Risk & Return - S&P 500 vs. Morningstar Indexes
Annualized 15 years through 12/31/2017
Thrivent Mutual Funds offers four different asset allocation funds that range from moderately conservative to aggressive. Although each of the Funds has an asset allocation target, the actual allocation can vary depending on the outlook and judgment of the Fund manager. The Funds are professionally and actively managed by a team of more than 100 investment professionals.
For example, the Thrivent Moderately Aggressive Allocation Fund has a target asset allocation of 77% equity securities and 23% fixed income securities, but the actual allocation typically varies somewhat as the Fund manager makes adjustments in the holdings to react to changing market and economic conditions.
The Thrivent Moderately Aggressive Allocation Fund typically invests in more than a dozen different asset groups. The largest group has been large capitalization U.S. stocks, which typically accounts for about a third of the Fund’s total assets. The Fund also invests in several other equity groups, including international, small cap, mid cap, and “opportunistic equity” (such as natural resources stocks or real estate investment trusts). Bonds and other debt instruments make up the balance of portfolio assets, led by securitized debt, investment grade credit, short-term bonds and cash, and government bonds. Other bond instruments include high yield bonds, floating-rate bank loans and international debt.
The diversification of these asset allocation funds makes them less volatile than the performance of a single equity category, such as a fund that invest primarily in mid-cap stocks. Although the more conservative portfolios would tend to have lower potential returns over the long-term, their losses tend to be more modest and less frequent than the more aggressive investments.
Gauging Volatility and Risk
To gauge volatility, investors often use a metric known as “beta.” Beta is a statistical measure of the volatility, or market risk, of an investment compared to a benchmark. The lower the beta, the lower the volatility of the investment compared with the benchmark.
The S&P 500 composite index is considered a beta baseline, with a beta of 1.0. Anything over 1.0 is considered more volatile or risky than the market and anything under 1.0 is considered less volatile and less risky. For example, over a recent three-year period through December 31, 2017, the Thrivent Moderately Aggressive Allocation Fund – Class S had a beta of 0.79, which indicated that it was 21% less volatile than the S&P 500 during that period.
In addition to the Thrivent Moderately Aggressive Allocation Fund, Thrivent also manages three other asset allocation funds, giving investors with moderately conservative to aggressive risk tolerances the opportunity to choose a portfolio suited to their objectives and threshold for risk:
- Thrivent Moderately Conservative Allocation Fund. The target allocation for this fund is 63% fixed income securities and 37% equity securities. While this fund would probably trail the market and the other Thrivent asset allocation funds during a strong bull market, it would typically be the least volatile, with the lowest risk, during rocky periods in the market. Over a recent three-year period through December 31, 2017, the Thrivent Moderately Conservative Allocation Fund – Class S has had the lowest beta of the group at 0.37, which indicates that it was 63% less volatile than the S&P 500.
- Thrivent Moderate Allocation Fund. The fund’s target allocation is 57% of assets in equity securities and 43% in fixed income securities. Over the recent three-year period through December 31. 2017, the Thrivent Moderate Allocation Fund – Class S has had a beta of 0.58, which indicates that it was 42% less volatile than the S&P 500.
- Thrivent Aggressive Allocation Fund. This fund is geared to investors who want most of their assets in the stock market, but still prefer some diversification to offset the volatility of the market. The target allocation of the fund is 95% of assets in equity securities and the balance in fixed income securities. Over a recent three-year period through December 31, 2017, the Thrivent Aggressive Allocation Fund – Class S had the highest beta of the asset allocation fund group at 0.97, which indicated that it was 3% less volatile than the S&P 500.
Thrivent Mutual Funds has over 20 mutual funds, spanning most major asset classes, to help investors build diversified portfolios.
Although asset allocation funds cannot shelter you entirely from the ups and downs of the market, they can lower your exposure to the stock market and help reduce the volatility of your own portfolio over the long-term.
Learn more about Thrivent Asset Allocation Funds.
All data represents past performance. Past performance does not guarantee future results. The investment return and principal value of the investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than the original cost. Current performance may be lower or higher than the performance data quoted. See performance results current to the most recent month-end.
Indexes are unmanaged and do not reflect the fees and expenses associated with active management. Investments cannot be made directly into an index.
S&P 500® Index is an index of 500 stocks chosen for market size, liquidity and industry grouping, among other factors. The S&P 500 is designed to be a leading indicator of U.S. equities and is meant to reflect the risk/return characteristics of the large cap universe.
Asset Allocation Fund Risks: The Funds invest in other Thrivent Mutual Funds and in directly-held equity and debt instruments. The Funds are subject to their own fees and expenses and the expenses of the other funds in which they invest, and are subject to all of the risks of the other funds in which it invests. The value of the Funds is influenced by factors impacting the overall market, certain asset classes, certain investment styles, and specific issuers. The Funds may incur losses due to incorrect assessments of investments by its investment advisor. Foreign investments involve additional risks, including currency fluctuations, liquidity, political, economic and market instability, and different legal and accounting standards. Bond prices generally fall as interest rates rise. Credit risk is the risk that an issuer of a debt security may not pay its debt, and high yield securities are subject to increased credit risk as well as liquidity risk. The use of derivatives (such as futures and swaps) involves additional risks and transaction costs, which could leave the Fund in a worse position than if it had not used these instruments.
The Morningstar Target Risk Index family consists of five indexes covering risk preferences ranging from Aggressive to Conservative. The indexes utilize asset allocation methodologies developed and maintained by Ibbotson Associates to determine underlying index weighting. The five target risk indexes include: Aggressive (95% equities and 5% bonds), Moderately Aggressive (80% equities and 20% bonds), Moderate (60% equities and 40% bonds), Moderately Conservative (40% equities and 60% bonds) and Conservative (20% equities and 80% bonds).
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