Low volatility equity strategies have been popular with investors seeking safe and secure income. But are they in danger of becoming victims of their own success? Pádraig Floyd finds out.
Low volatility equity strategies have become increasingly popular with institutional investors. Given their promise of benchmark- like returns but with significantly less risk, it’s hardly surprising. The concept of low vol equity strategies was originally developed early in the century as there was a need for broad strategies within the high net worth field that offered volatility management and capital protection – the central planks of high net worth investment management. This later transitioned into the pension fund world as liability management and liability driven investment (LDI) developed. This required different measures of risk as tracking error was a busted flush as a generic benchmark was no longer the be-all-and-end-all. It then became a building block for client portfolios, says SEI portfolio manager and senior analyst, Eugene Barbaneagra. “The better-funded the pension fund, the higher the allocation, because they didn’t need as much growth and they required capital protection.” This could be achieved because the interest rate exposure within the strategies made them appear more like a 70/30 fund rather than 100% equity. Low vol strategies target high quality stocks that will be good dividend payers and deliver stable income streams. The stability can allow for more leverage. In an environment of falling interest rates, these low vol equities will hopefully show strong performance. Of course, Newton’s third law of motion is equally apposite in investment markets and rising interest rates will deliver much more mediocre performance. The strategy has been proven over the last decade or more, but there are growing concerns that they in danger of becoming victims of their own success. “They performed well for us and offered considerable downside protection in both 2008 and 2011,” says Barbaneagra. But their performance has made them more popular and there are lots of “performance chasers” looking to get into low vol on the back of a five or 10-year track record. But, as Barbaneagra points out, this follows the worst recession in a century and unprecedented interest rate lows.
“There is no panacea. I’ve seen low volatility strategies underperform falling markets, so they don’t necessarily offer capital preservation.”John Belgrove