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Blog Posts — June 10, 2020

The shifting sands of sector risk… When low-volatility sectors become high-volatility — and vice versa

by Diana R. Baechle, PhD

The coronavirus crisis has driven large changes in the relative risk of US sectors, with some low-volatility sectors turning into high-volatility sectors and vice versa. Traditionally defensive sectors, such as Real Estate and Utilities, lost their defensiveness, while typically cyclical, high-beta sectors, such as Info Tech, turned more defensive. Not surprisingly, in the midst of the pandemic, Health Care kept its defensive status and was among the few sectors to post a year-to-date gain as of May 29, along with Info Tech. At the same time, all four sectors have been moving more and more in line with the market.

If history is any indication of things to come, Utilities and Real Estate will revert to their medians within three to 12 months, but Info Tech may remain among the least risky sectors at least until the end of 2020.

Source: FTSE Russell, Qontigo

Utilities and Real Estate historically have been among the least risky sectors and have been considered defensive sectors, offering protection against market downturns. Their median rankings over the past three decades positioned Utilities and Real Estate as the second and third least risky sectors (after Consumer Staples), respectively, among the 11 US sectors. They showed the same rankings only five months ago, at the end of 2019. Since then, these two defensive sectors saw the largest shifts in their ranks across all sectors. By the end of May, Real Estate became the second riskiest sector, superseded only by Energy—which has maintained its position among the riskiest sectors for most of the past 30 years. At the same time, Utilities became the sixth riskiest sector at the end of May.

On the flip side, Info Tech—a cyclical sector whose risk has been historically superseded only by Energy—became one of the least risky US sectors, ranking fourth least risky by May end. Perhaps this is not surprising given that the current crisis has not been driven by a cyclical downturn in the economy, but by lockdowns that put Info Tech at the forefront of most human activity. As working from home became commonplace and with virtual social interaction now the norm, Info Tech turned into a staple.

Given the demands for Health Care during the pandemic, the sector outperformed and ended May at a lower relative level of risk than at the start of the year. Health Care, whose long-term median rank (of five) positioned it in the middle of the pack historically, became the second least risky sector after Consumer Staples by May 29.

Consumer Staples and Consumer Discretionary were the only two sectors not to see a shift in their long-term rankings, while other sectors saw lower-magnitude changes in their relative risk. The risk we use in this analysis is based on the predicted volatility from the Axioma’s US All Cap fundamental medium-horizon model.

From low to high relative volatility: Real Estate and Utilities

This is not the first crisis in which Real Estate reached top rankings in terms of relative risk. Over the past 15 years, Real Estate found itself at the top of the chart multiple times, but just briefly. Only during the Subprime Mortgage Crisis, when Real Estate was the epicenter, did it remain among the riskiest sectors for more than a year.

The rank of Utilities has oscillated greatly since 2014, especially when compared with the prior 24 years when the sector was perennially among the least volatile. More recently, Utilities’ relative risk has risen, surpassing the sector’s rank during the Global Financial Crisis on multiple occasions over the past six years. Still, while Utilities’ relative risk jumped in 2020, it remained lower than near-term peaks observed in recent years. We do not expect Utilities’ relative risk to remain high, as we note that historically it has reverted to its median within three to four months after seeing a jump in risk.

Source: FTSE Russell, Qontigo

From high to low relative volatility: Info Tech

The current level of low relative risk for Info Tech has been seen only twice over the past three decades: during the Global Financial Crisis, and in 2017. It took about five years for Info Tech to revert to its median rank of 10 (with one signifying the lowest risk and 11 the highest risk) after the Global Financial Crisis troughs, but less than one year to switch from being one of the lowest-risk sectors in April 2017 to one of the riskiest in February 2018. It is interesting to note that after the dust from the internet bubble and subsequent burst settled, Info Tech had transformed, and has been much more likely to be among the lower risk sectors. Its shift toward being a “staple” started well before this current crisis.

From low to even lower relative volatility: Health Care

Health Care’s relative risk has been coming down since the peaks reached in 2014 after the implementation of the Affordable Care Act provisions, and since 2018 it has remained among the least risky sectors. As mentioned above, the sector benefited from the coronavirus pandemic, with its relative risk declining since the beginning of the year. Health Care became the second lowest risk sector after Consumer Staples on May 29.

All four sectors move more in line with the US market

Interestingly, all four of these sectors saw their exposure to the Market Sensitivity factor get closer to zero[1] in 2020. That is, all four sectors have been moving more in line with the market.

Generally, Real Estate and Utilities have had negative Market Sensitivity exposures, meaning that they have typically been less risky than the market, but they both flipped signs in the recent months. Since the beginning of the year, the exposures went from about -1.0 to +0.2 for Real Estate and from -1.3 to 0 for Utilities.

Health Care’s exposure to Market Sensitivity remained negative, declining from -0.3 to -0.2.

Info Tech’s exposure flipped signs, falling from +0.5 at the beginning of 2020 (also its long-term average) to -0.2. That is, Info Tech went from having an expected risk higher than the market, to one lower than the market.

These sudden and large changes in Market Sensitivity exposures potentially resulted in high portfolio turnover, especially for portfolios tilting on this style factor, an issue addressed in the blog post Market Sensitivity Exposures: “And the ‘New Normal’ is …”.

Source: FTSE Russell, Qontigo

As reflected in the sign changes of their Market Sensitivity exposures, Utilities and Real Estate became less defensive, while Info Tech became more so since the beginning of the year. Unsurprisingly, Health Care maintained its defensive nature. The sectors’ total predicted risk followed a similar pattern. Low-risk sectors, such as Real Estate and Utilities, saw higher predicted volatility than Info Tech and Health Care by the end of May.

Info Tech and Health Care outperform

Investors turned to Utilities and Real Estate in January and February 2020 to immunize their portfolios, as concerns about the coronavirus pandemic increased, strongly outperforming all other sectors (except Info Tech) by the time market peaked on February 19. They both plummeted in March and rebounded in the second quarter, mirroring the moves of the US market overall. But by the end of May, Real Estate and Utilities were no longer among the best performing sectors, as both recorded year-to-date losses of 12% and 6%, respectively. Info Tech remained in the lead with a year-to-date return of 8%, while Health Care reported the third largest positive year-to-date return (of 2%) after Info Tech and Consumer Discretionary.

Source: FTSE Russell, Qontigo

These significant changes in sector characteristics were also reflected in our sector-based sentiment indicators (Sector-based ROOF scores), which classify sectors as having either a risk-tolerant or a risk-averse “personality.” The blog post Amid Covid-19, some sectors are misbehaving—with a big impact on turnover for sentiment aware investors shows that Real Estate went from being a risk-averse sector before the crisis to a risk tolerant one. Also, Utilities lost its risk-averse characteristic and became neutral, while Info Tech also became neutral but after being decisively risk tolerant.


The coronavirus pandemic drove significant changes in the risk characteristics of US sectors, which have important implications for managing portfolio risk. Defensive sectors, which typically have relative low risk and a low beta, such as Utilities and Real Estate, turned into risky sectors. At the same time, Info Tech—a cyclical sector that has ranked among the riskiest sectors historically—became one of the lowest volatility sectors. If history were to repeat itself, we would expect the shifting sands of relative risk to switch back, with the typically low-volatility sectors reverting to their historical positions within three months to one year. Given how it has become inextricably entrenched in everyday life, Info Tech may hold onto its low-risk position for much longer than that.

[1]Although the exposure to Market Sensitivity is akin to beta, it is expressed as a z-score exposure like all of Axioma’s risk factors. One can think of a Market Sensitivity exposure of 0 being roughly equivalent to a beta of 1.