Insights | Volatility reduction: How minimum variance indexes work

Minimum variance indexes, which apply rules-based methodologies with the aim of minimizing an index’s volatility, are popular among market participants interested in smart beta. In this FTSE Russell Insights, the third in a series of three covering risk-based indexes and their applications, we review minimum variance indexes in detail.

We discuss the reasons for the recent popularity of the minimum variance approach. We also note the importance of the design choices facing the creator of a minimum variance index, which can determine the index’s suitability for use by market participants as a benchmark or as the underlying target for an index-replicating portfolio or financial product.

Using the example of a minimum variance index constructed from the Russell 1000® Index, we also review the reasons for why a minimum variance strategy has captured reduced volatility in index levels and examine its recent valuation levels.

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