Is there a paradox that the managed volatility strategy has outperformed the benchmark when the benchmark performance has been so high over the period, and when the beta of the strategy is supposed to be much lower than the beta of the benchmark?

1. Part of State Street’s Vision thought leadership series
SSgA CAPITAL INSIGHTS VIEWPOINTS
PHOTO
by
Frederic Jamet
Head of Investments SSgA France
The Q1 2013 Managed Volatility
Performance Paradox
What is the Paradox?
The Global Managed Volatility strategy aims to create a 100%
equity portfolio with minimum volatility within the MSCI World
universe. This strategy uses quadratic optimization in order to
produce the minimum ex ante volatility with the minimum set
of other constraints.
One major feature of the strategy is the low beta. This is a direct
consequence of the minimum volatility tilt. The typical
ex ante beta of the strategy is 0.6, which means that, according
to the CAPM theory, the excess return of the strategy should
be equal to 0.6 times the excess return of the market, i.e. the
MSCI World index. As such, the strategy is intended to offer
some downside protection in exchange for limited participation
in market rises.
However, from 31 December 2012 to 30 April 2013 the
performance of the Global Managed Volatility strategy has been
+16.31% versus +11.35% from MSCI World, outperforming the
benchmark by +4.96%.
Is there a paradox that the managed volatility strategy
has outperformed the benchmark when the benchmark
performance has been so high over the period, and when the
beta of the strategy is supposed to be much lower than the beta
of the benchmark? We investigated further.
Where does the Managed Volatility Paradox Come From?
It appears that the current characteristics of the managed
volatility strategy (as described in Figure 1) are in line with the
general description of the strategy, notably a low absolute risk,
a low predicted beta (less than 0.7) and a high tracking error
(more than 5%).
The absolute risk is much lower and this is the first objective
of the strategy. The beta is significantly lower at 0.65 and this
contributes to the high predicted tracking error of 6.0%.
The factor exposure supports this analysis.
Figure 1: Risk Characteristics of Global Managed Volatility
Strategy vs. MSCI World
Risk Characteristics
SSgA Global
Managed Volatility MSCI World
Predicted Tracking Error 6.00 --
Absolute Risk 9.57 13.82
Predicted Beta 0.65 1.00
R-squared 0.87 1.00
Percent Stock Specific Risk 5.63 #N/A
Percent Factor Risk 94.37 #N/A
Source: Factset. April 2013

2. 2
SSgA CAPITAL INSIGHTS | Q1 2013 MANAGED VOLATILITY
The largest factor difference by far is the volatility exposure.
Here the managed volatility strategy is underexposed at
-0.54 versus -0.11 for the benchmark.
To understand the current outperformance—outperformance
obtained while the strategy is in line with our expectations in
terms of risk profile—we ran a performance attribution analysis
by sector. In fact the main driver of the overperformance over
the quarter is mostly the difference in sector distribution
(detailed in Figure 3).
Logically, the managed volatility strategy is actively concentrated
in the less volatile sectors such as Consumer Staples and
Utilities and is actively underweighted in the most volatile
sectors such as Financials and Energy.
It appears that the sector dynamics during the quarter resulted
in a flight to quality and to underexposure to volatility at a time
when the most volatile sectors—such as Materials and Energy
and Technology—have significantly underperformed and
the less volatile sectors—such as Healthcare and Consumer
Staples—have overperformed.
Figure 4: Evolution of the Managed Volatility Strategy’s
Value Factor
— Value
Dec
2007
20092008 2010 2011 2012 Mar
2013
Factor Exposure Level
-0.6
-0.4
-0.2
0.0
0.2
0.4
0.6
0.8
Source: Factset. April 2013
Figure 2: Portfolio Risk Factor Exposure of Global Managed
Volatility Strategy vs. MSCI World
Data Data Difference
Exchange Rate Sensitivity 0.07 -0.04 0.11
Growth -0.18 -0.03 -0.15
Leverage 0.32 -0.01 0.33
Liquidity -0.12 0.20 -0.32
Medium-Term Momentum 0.03 0.02 0.01
Short-Term Momentum 0.14 0.04 0.10
Size -0.04 0.24 -0.28
Value -0.31 -0.03 -0.28
Volatility -0.54 -0.11 -0.42
Source: Factset. April 2013
Figure 3: Performance Attribution
SSgA Global Managed Volatility MSCI World Variation Attribution Analysis
GICS_SECTOR
Port.
Average
Weight
Port.
Total
Return
Port.
Contrib.
To
Return
Bench.
Average
Weight
Bench.
Total
Return
Bench.
Contrib.
To
Return
Average
Weight
Difference
Total
Return
Difference
Contrib.
To Return
Difference
Allocation
Effect
Selection
+
Interaction
Total
Effect
Consumer Discretionary 6.86 17.79 1.22 11.26 14.41 1.60 -4.39 3.37 -0.38 -0.11 0.22 0.12
Consumer Staples 24.39 17.73 4.32 10.82 16.44 1.73 13.57 1.28 2.59 0.69 0.31 1.00
Energy 0.01 6.13 0.00 10.09 5.89 0.63 -10.08 0.24 -0.63 0.54 0.02 0.56
Financials 8.77 12.32 1.09 20.58 13.64 2.77 -11.81 -1.32 -1.68 -0.24 -0.12 -0.36
Health Care 18.77 17.90 3.37 10.85 19.10 2.00 7.92 -1.20 1.38 0.61 -0.18 0.44
Industrials 1.71 3.00 0.06 10.95 9.72 1.07 -9.25 -6.72 -1.02 0.15 -0.12 0.04
Information Technology 1.69 11.51 0.20 11.63 6.60 0.78 -9.95 4.91 -0.58 0.49 0.10 0.60
Materials 0.34 15.22 0.05 6.38 -4.10 -0.27 -6.05 19.32 0.32 0.98 0.08 1.07
Telecommunication Services 11.58 15.97 1.86 3.77 15.46 0.57 7.81 0.50 1.29 0.34 0.08 0.41
Utilities 24.86 16.72 4.12 3.41 14.16 0.48 21.44 2.56 3.64 0.48 0.66 1.14
[Cash] 0.39 -0.44 -0.01 -- -- -- 0.39 -0.44 -0.01 -0.04 -- -0.04
[Unassigned] 0.63 0.95 0.02 0.24 -12.21 -0.02 0.38 13.16 0.04 0.01 -0.02 -0.01
Total 100.00 16.31 16.31 100.00 11.35 11.35 -- 4.96 4.96 3.92 1.04 4.96
Source: Factset. April 2013
Past performance is not a guarantee of future results.
Index returns are unmanaged and do not reflect the deduction of any fees or expenses. Index returns reflect all items of income, gain and loss and the reinvestment of dividends and other income.
Sectors shown are as of the date indicated and are subject to change.

3. 3© 2013 State Street Corporation. All Rights Reserved. ID2712-EUMKT-2921 0513 Exp. Date: 31/05/13
SSgA CAPITAL INSIGHTS | Q1 2013 MANAGED VOLATILITY
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The views expressed in this material are the views of Frederic Jamet through the period ended April 30, 2013 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
document contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or
developments may differ materially from those projected. Past performance is not a guarantee of future results.
Investing involves risk including the risk of loss of principal.
Risk associated with equity investing include stock values which may fluctuate in response to the activities of individual companies and general market and economic conditions.
SSgA generally delegates commodities management for separately managed accounts to SSgA FM, a wholly owned subsidiary of State Street and an affiliate of SSgA. SSgA FM is registered as a
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This communication is not specifically directed to investors of separately managed accounts (SMA) utilizing futures, options on futures or swaps. SSgAFM CTAclients should contact SSgA
Relationship Management for important CTA materials.
This document provides summary information regarding the Strategy. This document should be read in conjunction with the Strategy’s Disclosure Document, which is available from SSgA.
The Strategy Disclosure Document contains important information about the Strategy, including a description of a number of risks.
A large part of the 4.96% overperformance, 3.92%, comes from
the sector allocation and only a residual part, 1.04%, comes
from the selection effect. Thus, this overperformance would
have been replicated by any active sector funds that took this
defensive allocation during the quarter, irrespective of a low
volatility stock picking requirement.
Finally, the historical evolution of the Managed Volatility
Strategy’s value and momentum factors, since 2007, is shown
on Figure 4. From 2009 to 2011 the exposure to value was
positive. This can be interpreted as indicating that the Managed
Volatility Strategy was inexpensive relative to the value factor.
The exposure to value became negative in 2012 and 2013.
This could be interpreted as indicating that the Managed
Volatility Strategy is now expensive relative to the value factor.
Conclusion
The managed volatility strategy shows all the characteristics
of a low volatility strategy from an ex ante volatility (lower than
the volatility of the market), beta (lower than the one of the
market) and factor exposures (largely underexposed to
volatility factor) perspective.
The first quarter overperformance comes largely from the sector
allocation. It seems that the defensive sectors have largely
overperformed the cyclical sectors during the quarter.
It appears that a low beta strategy such as the managed
volatility strategy can significantly outperform the benchmark
even when the market is rising. Investors should bear in mind
not only the expected return of the strategy that is associated
with the beta, but also the absolute risk (low) and relative risk
(high) vis-a-vis the benchmark. On the other hand, however,
investors should be aware of the source of this overperformance
and should realise that being underexposed to volatility is now
becoming more expensive (in the sense of the value factor) than
it was before.