1) The Global Managed Volatility strategy has outperformed the market index over the past 13 years while significantly reducing risk, as measured by volatility. 2) The strategy's outperformance is driven by its low exposure to the underperforming market factor during this period, as well as positive exposure to the value and small-cap factors. 3) Exposure to value stocks can be attributed to these stocks' neglected nature and de-correlated behavior, while exposure to small-caps comes from their greater number leading to more frequent selection in a non-market cap weighted strategy. The strategy's performance is diversified across multiple factors rather than relying solely on volatility reduction.

1. Part of State Street’s Vision thought leadership series
SSgA CAPITAL INSIGHTS THE EXCHANGE
What are the Performance
Drivers of the Global Managed
Volatility Strategy?
The Modern Portfolio Theory developed by Harry Markowitz
and William Sharpe explored the concept of efficient portfolios.
An efficient portfolio is one which delivers the maximum
expected return for a defined level of risk. Under the theory, the
market capitalization portfolio—which is held to be approximated
by the MSCI World index—is efficient. A portfolio which has
the minimum expected volatility is also supposed to be efficient
since no portfolio should have a lower risk. According to the
theory, and to common sense, the minimum volatility portfolio
should have a lower volatility and a lower performance than the
market capitalization portfolio.
However and perhaps surprisingly, it appears that for the
past 13 years the minimum volatility portfolio has experienced
a consistent outperformance versus the market capitalization
portfolio. And this has been coupled with a consistent reduction
of risk (as expressed by volatility).
Does this performance come solely from the pure low-beta
characteristic of the strategy or is there any kind of contribution
coming from value or small-cap exposure? This piece explores
the performance drivers of this kind of strategy.
Implementing a Minimum Volatility Strategy
The concept of the theoretical minimum volatility can be practi-
cally implemented through strategies such as SSgA’s Global
Managed Volatility product, or through index provider ­strategies
such as the MSCI World Minimum Volatility Index or the STOXX
Global 1800 Minimum Variance Index. The SSgA Global
Managed Volatility strategy aims to create a 100% equity portfolio
within the MSCI World universe. It uses quadratic optimization
in order to produce the minimum volatility with the minimum set
of other constraints. To judge its performance, we will review the
strategy compared to its two natural benchmarks.
The first of these is the MSCI World strategy. This is the market
capitalization index and the efficient benchmark according
to Modern Portfolio Theory. The other is the Equi Weighted
strategy. This strategy gives equal weight to every stock of the
MSCI World population. It is readjusted back to equal weight
every quarter. Some consider this Equi Weighted strategy to be
the most appropriate benchmark because it gives the universe
of possible investment without taking into account information
such as market capitalization. As such, it could be considered
as perfectly neutral.
Chart 1 shows the performance and risks (volatility) of the
3 strategies. The 1998–2011 period is used in order to have at
least the typical 10 years and to include the technology bubble.
The Global Managed Volatility strategy has experienced a strong
outperformance over the MSCI World, showing both an increase
in performance and a decrease in volatility. The decrease in
volatility was expected since the strategy has been designed to
minimize volatility. However, the outperformance would not be
expected according to theory. To understand this result more,
we analyse the sources of the outperformance below. The
Equi Weighted World strategy has experienced a comparable
­magnitude of outperformance but with higher levels of volatility,
that is, with more risk.
by
Frederic Jamet
Head of Investments, SSgA France
Chart 1: Performance and Risk of the 3 Strategies
Annualized
Return (%)
Annualized
Volatility (%)
Global Managed Volatility 7.96 10.71
Equi Weighted World 7.04 18.02
MSCI World 2.44 16.65
From 1998 to 2011, in USD
Source: MSCI, SSgA

2. SSgA CAPITAL INSIGHTS | THE EXCHANGE
2
The 3 Performance Factors—Market, Value and Small-cap
In his Capital Asset Pricing Model theory, or CAPM, William
Sharpe suggested that the performance of a portfolio arises
from a unique factor: the market factor, or beta. This concept
has since been extended by Eugene Fama and Kenneth
French, who suggested adding 2 other factors: the small-cap
factor and the value factor.
The Factor Calculation
We have computed the value and small-cap factors in a
straightforward way in order to follow the Fama and French
approach. (This computation was made specifically in order to
have the same systematic approach for value and small-cap
factors: this is not the standard MSCI computation.)
Each year the MSCI World is split into 2 halves that represent
each 50% of the MSCI World market cap. The high value stocks
are the 50% bottom Price/Book (P/B) whereas the low value
stocks are the 50% top P/B. The value factor is then the perfor-
mance of the bottom P/B stocks minus the performance of the
top P/B stocks. The small-cap factor represents the performance
of the 50% bottom market cap stocks minus the 50% large
market cap stocks. Each factor is recomputed every year.
The market factor is represented by the MSCI World index
minus the T-Bill 3 months USD (which represents the risk-free
rate i.e. the interest an investor would expect from an absolutely
risk-free investment over a period of time). The performances
and risks of the 3 factors are described below in Chart 2.
Historical returns represent the 1926–2009 performance of
comparable factors in the US market.
The market factor has produced a poor performance over the
period since the MSCI World has underperformed the risk-free
rate for the 13 year period we are assessing. Consequently,
any strategy that has been underexposed to the market—such
as Global Managed Volatility, or any blend of market-exposed
strategy and risk-free rate or fixed income—is likely to have
overperformed. It should be noted that this past 13 years of
underperformance for the MSCI World could be considered an
unusually bad performance, when compared to historical returns.
The value and small-cap factor have had a positive and material
outperformance for the past 13 years, more or less in line with
the long-term historical return.
Performance Drivers of the Global Managed Volatility Strategy
Chart 4 shows the factor exposures of each of the 3 strategies,
for the period 1998 to 2011.
Both the Global Managed Volatility strategy and the Equi
Weighted strategy have relatively comparable exposure.
They both have a significant positive exposure to the market,
value and small-cap factors. Both exhibit a monthly positive
alpha although not significantly different from zero. The Global
Managed Volatility strategy has a lower exposure to the market
factor, or beta; and the Equi Weighted strategy has a higher
exposure to the small-cap factor.
The value exposure of the Global Managed Volatility strategy
can be explained by the fact that a neglected stock has a
de-correlated behaviour. Neglected stocks probably have a
value bias because they are neglected, and will be overweighted
in the Global Managed Volatility strategy because they
are de-correlated.
Chart 2: MSCI World Performance and Risk Breakdown,
1998–2011
Annualized
Return (%)
Annualized
Volatility (%)
Historical Return
(1926–2009) (%)
Market Factor -0.03 16.66 5.18
Value Factor 2.91 8.75 2.60
Small-cap Factor 5.01 6.87 5.00
From 1998 to 2011 in USD
Source: MSCI, SSgA, Historical Charts from Dimson, Marsh, Staunton on 1926–2009 in USA
Chart 3: Relative Performance of the 3 Strategies and
Component Factors
Source: MSCI, SSgA
— MSCI World
— Value Factor
— Managed Volatility
— Small Cap Factor
— Equal Weight
Performances
Cumulative Perfomances in (%)
0.5 Dec
1998
2002 2006 2010 Dec
2011
1.0
1.5
2.0
2.5
3.0
Chart 4: Exposure to the 3 Factors, 1998–2011
Market
Exposure (%)
Value
Exposure (%)
Small-cap
Exposure (%)
Alpha
(%)
R2
(%)
Global Managed
Volatility
49.5 16.4 27.5 0.3 73.6
Equi Weighted 100.1 13.0 53.6 0.1 98.1
MSCI World 100.0
From 1998 to 2011 in USD. All Charts significant at 95% level except the Alpha Charts which
is not significantly different from zero.
Source: MSCI, SSgA

3. SSgA CAPITAL INSIGHTS | THE EXCHANGE
3
The small-cap exposure can be explained by the fact that any
strategy that is not market-cap weighted tends to select stocks
more frequently in the small-cap area, because small-cap
stocks are more numerous.
The variance of the strategies, or the source of the performance
and volatility are analysed in the Chart 5. Variance is considered
here as the square of the annualized volatility where volatility is
the standard deviation of the monthly rate of returns.
The major contributor to the total variance, i.e. the major driver
of the strategy, is the market factor. The outperformance of the
Global Managed Volatility strategy comes firstly because of the
low beta, or low exposure to the market factor. However a signif-
icant source of variance comes from the small-cap and value
factors, and from their combination.
In fact it seems that, according to the variance analysis, the value
added of the Equi Weighted strategy comes from the high over-
exposure and outperformance of the small-cap factor. The Global
Managed Volatility strategy seems more complex: its sources of
value added are more diversified amongst value and small-cap,
and a significant part of the variance remains unexplained.
Conclusion
As expected the Global Managed Volatility strategy has offered
a significant reduction in volatility during the part 13 years.
However, additionally, the strategy has significantly outper-
formed the MSCI World index.
The main driver of the strategy’s performance has been the
low exposure to the market or the exposure to a low beta factor,
and the mediocre performance of the market. These have
contributed 59% of the total variance.
However the Global Managed Volatility strategy is also signifi-
cantly exposed to value and small-cap factors. This exposure is a
structural part of the strategy. They have contributed 14% of the
total variance. It thus appears that the Global Managed Volatility
strategy offers not only a simple volatility reduction, but also a
larger and more diversified exposure to other risk premiums.
Chart 5: Variance from the 3 Factors
Total
Variance (%)
Variance
Explained (%)
From Market
only (%)
From Value and Small-cap
beyond Market (%)
From Value
only (%)
From Small-cap
only (%)
Global Managed Volatility 100.0 73.6 59.1 14.5 1.8 3.1
Equi Weighted 100.0 98.1 85.5 12.7 0.4 6.8
MSCI World 100.0 100.0 100.0
From 1998 to 2011 in USD
Source: MSCI, SSgA

4. SSgA CAPITAL INSIGHTS | THE EXCHANGE
4
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The views expressed in this material are the views of Frederic Jamet through the period ended July 31, 2012 and are subject to change based on market and other conditions. The information
provided does not constitute investment advice and it should not be relied on as such. All material has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. This
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