Key takeaways

  • Allocating to different equity types can reduce risk over time.
  • Defensive equities could be superior to just shifting the equity/bond mix for investors, especially those near retirement.
  • Over the long term, growth stocks are less volatile than many assume.

Asset allocation is one of the most important investment planning decisions.

The key question: What is the best mix between stocks and bonds, and how should that mix change over time? By focusing on diversification, however, we may lose an important distinction: Not all equities are created equal.

Different types of stocks exhibit unique risk and return characteristics that can help offset the changing risks investors face. Better outcomes can be achieved by harnessing these traits, rather than simply holding the broad equity market and adding more bonds.

Although the philosophy of different equities for different investors may have fallen out of style, it predates foundational concepts such as modern portfolio theory and the capital asset pricing model by at least 50 years. It is worth revisiting.

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A new view of risk

Although there are other ways to slice the market — by yield, by market capitalization, by valuation — we found that beta, a measure of a stock’s sensitivity to overall equity market risk, forms a relatively simple way to distinguish between growth and defensive companies.

Using more than five decades of historical data, we found that higher beta stocks were riskier and more volatile but offered higher returns than lower beta stocks. Which isn’t surprising. But a compelling new perspective is revealed by  reconsidering how volatility is measured.

The upside of a smaller downside

For investors with a shorter time horizon, such as those nearing retirement, defensive lower beta equities have delivered superior results in periods of market stress. This group has produced better downside protection and enhanced returns compared to a mixed stock/bond portfolio that just reduces its stock allocation in favor of bonds over time.

This is why we focus on income-oriented stocks in portfolios for investors nearing retirement. These have had a more conservative profile that helps reduce the risk of losses while at the same time keeping a healthy allocation to equities, which offer higher long-term returns compared to bonds.

Plotting the beta cohorts against their downside capture — a measure of how exposed they are to broad market pullbacks — draws out an important distinction. Traditional measures of risk weigh upside and downside outcomes equally, but sometimes losses hurt more. 

Put simply, low-beta stocks demonstrated less downside and more upside than expected. Compared to simply holding the entire equity market, the most defensive Q1 (low beta) portfolio has yielded nearly the same average return for a more than 40% reduction in downside capture risk. Adding bonds to a portfolio could have lowered downside, but with far lower average returns.  

The benefits of bouncing back

For those with longer time horizons, such as young investors with the stomach to stay the course in the midst of selloffs, more cyclical, higher beta equities have yielded better outcomes. This is why we emphasize growth stocks in portfolios for investors early in the savings cycle.

To illustrate this point, we plotted the beta cohorts by their volatility over a long-term holding period of 20 years. Portfolios that held higher beta equities would have earned higher total returns, helping offset the chances of inadequate savings at retirement, at a lower level of long-term risk compared to simply increasing exposure to the broad market.

Although high beta stocks tended to lose more value during market downturns, they often bounced back — a reflection of their growth-oriented nature.

Sure, short-term market volatility can be emotional and worrisome for those invested in higher beta stocks. But for those with the discipline to remain invested during volatile stretches, these corrections and selloffs may be eclipsed by the market’s tendency to rise over multi-decade periods.

Far from a new idea

The mutual fund industry in the U.S. got its start by holding different kinds of equities to fulfill specific investment objectives. Retirees typically invested in funds of blue chip, dividend-paying companies, while others invested in funds seeking appreciation and high total returns.

The equity differentiation strategies outlined here have fallen out of favor in an era of passive investing, indexing and market efficiency. This is unfortunate, as the often singular focus on portfolio diversification has led many to forget that equity diversity can be a powerful risk reduction tool.

Investors face varied and changeable risks as they age. So why should their equity exposure — often simply an allocation to the Standard & Poor’s 500 Composite Index via a low-cost index product — remain the same? By viewing the stock market not as a homogeneous block but as a mix of individual issues with unique characteristics, better investment outcomes can be achieved. 


Sunder Ramkumar is senior manager of client analytics at Capital Group. He has 15 years of investment industry experience and has been with Capital Group for four years. Prior to joining Capital, Sunder was a managing director and portfolio manager at BlackRock. His research on asset allocation and optimal investment strategies has been published in The Financial Analysts Journal, The Journal of Portfolio Management and The Journal of Fixed Income. He holds a master’s in management science and engineering from Stanford and a bachelor’s in mechanical engineering from Mangalore University, India. He is also a CFA charterholder.


Standard & Poor’s 500 Composite Index is a market capitalization-weighted index based on the results of approximately 500 widely held common stocks. This index is unmanaged, and its results include reinvested dividends and/or distributions but do not reflect the effect of sales charges, commissions, account fees, expenses or U.S. federal income taxes. Investors cannot invest directly in an index. Standard & Poor’s 500 Composite Index (“Index”) is a product of S&P Dow Jones Indices LLC and/or its affiliates and has been licensed for use by Capital Group. Copyright © 2019 S&P Dow Jones Indices LLC, a division of S&P Global, and/or its affiliates. All rights reserved. Redistribution or reproduction in whole or in part is prohibited without written permission of S&P Dow Jones Indices LLC.

Bond allocation in equity/bond mixed portfolios represented by five-year constant maturity U.S. Treasury notes.