What Research Says About Using Gold to Mitigate Downside Risk in a Portfolio

Many investors use gold as a way to limit portfolio losses during down markets. This approach, however, begs one question: What portion of the holdings should be gold in order to provide protection without sacrificing a return? Researchers at the Lancaster University Management School decided to find out.

The researchers examined annual real returns for hypothetical portfolios consisting of equities, bonds, and gold. Their analysis was designed to allow all three investments to compete “head-to-head in a multi-asset portfolio context to empirically examine their ability to serve investors’ need for downside risk protection.”

They started their research with a review of gold’s performance as a safe haven asset and concluded that “gold would have served as a safe haven in some 76% of the observed down markets in equities.” However, they are quick to remind investors that this protection carries a cost because gold is down half of the time that stocks are up.

Nevertheless, data going back to 1975 shows that even a small allocation to gold within a portfolio of equities and bonds lessens the risk of capital losses by about 10% across many different equity-bond allocations. Moreover, the researchers discovered that downside risk can be mitigated even further when investors choose low-volatility equities to replace part of their bond allocation. This defensive mix consists of 10% gold and 45% low-volatility equities and bonds. This allocation represents the “nose” of the efficiency frontier resulting in a downside volatility to 3.7%.