This is a sponsored article from Natixis Investment Managers.
Low volatility investing has grown in popularity over the past five years – but research by Seeyond1 suggests many investors are only partially aware of what low volatility really is. Low volatility investing remains prone to misconceptions as it runs counter to popular thinking. For those who fully understand the concept, the challenge is to reconcile the strategy with investment processes still largely developed around the belief that higher risk leads to higher rewards.
Ever since Harry Markowitz laid the foundations of the modern portfolio theory in 1952, the maxim that higher risk leads to higher returns has been widely embraced. As a result, many investors embark on riskier ventures, believing that low risk positions generally lead to low returns. This “no pain, no gain” philosophy determines how many opportunities are evaluated and investment decisions made.
A different perspective
The surprising reality, however, is that low volatility stocks have consistently outperformed high volatility stocks in both US and international markets since as long ago as 1926. Seeyond’s research team has scrutinised data for global equities between 1995 and 2016 and found that low risk global equities, measured by volatility, outperformed higher risk global equities in one market cycle after another2.
Investors tend to weigh emotional factors in addition to performance and risk when buying and selling securities. When volatility strikes, the urge to react to sudden market movements can sway even the most steadfast investor. Our natural bias toward short-term history, negative news, and risk aversion can overwhelm other considerations. Although we may be committed to avoid buying high and selling low, our instincts can push us in that direction when markets start to falter.
This behaviour creates portfolios with more volatility, less diversification, and lower returns. At Seeyond, we believe it is essential to try to manage behavioural and cognitive biases as part of any sound investment strategy. One way is to choose investments that are less sensitive to volatility. Minimum volatility strategies should seek to dissuade investors from making irrational investment decisions while aiming to deliver portfolio diversification, volatility reduction, and alpha generation.
Low volatility, high performance
Seeyond’s research suggests low volatility stocks have the potential to be among the best endurance performers in the equity market compared with higher volatility equities.2 Seeyond’s minimum volatility approach is designed to achieve equity-like returns with significantly lower volatility, helping investors stay engaged through all market conditions. Our strategy seeks to absorb market shocks, move with a lower beta, and maintain lower volatility over time.
Who benefits from low volatility stocks?
Minimum volatility strategies may be helpful for three specific types of investors in terms of portfolio application:
1. Investors who need equity returns but cannot endure high equity market volatility. A core allocation in minimum volatility has the potential to increase visibility on return dispersion compared with traditional equity investments.
2. Active investors seeking to tactically adjust their equity exposure within a long-only equity portfolio.
3. More aggressive investors who want their equity allocation to work harder. A core allocation in minimum volatility strategies has the potential to free up some risk budget.
The combination of a long-running bull market, interest rate hikes, and geopolitical turmoil could make markets more volatile in 2019. Because of this, investors may want to consider how they are preparing for increased turbulence and guard their portfolios against short-term emotional decision making that could prevent them from achieving their long-term investment goals.
2 Seeyond research represents returns of stocks included in the MSCI All Country World Index (Net) from 1995 to 2016. Stocks are equal weighted and quintiles are rebalanced on a quarterly basis. Seeyond study consists of classifying stocks across various broad-based indexes by risk (as measured by standard deviation) into risk quintiles and comparing the returns of Quintile 1 (lowest quintile: represents low risk stocks based on volatility) with the returns of Quintile 5 (highest quintile: represents high risk stocks based on volatility) over various periods. A quintile is a statistical value of a data set that represents 20% of a given population. Source: Bloomberg/Seeyond.Performance data represents past performance and is no guarantee of, and not necessarily indicative of, future results. Results may vary when analyzing different time periods.
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Past performance information presented is not indicative of future performance. Certain information included in this material is based on information obtained from other sources considered reliable. However, Natixis Investment Managers Singapore does not guarantee the accuracy of such information.
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This is a sponsored article from Natixis Investment Managers.