Value in managed volatility are drawn from equity-like exposure with lower volatility, similar returns, and better downside performance.
When clients seek a financial adviser’s counsel, they normally rouse their dreams of a major upside and it is very important that clients be assisted in their risks by creating a balanced portfolio that isn’t constricted but more importantly flexible and smart.
A new generation of products is gaining popularity and it is characterised as a multi-asset, outcome-based or solution based.
An example of an outcome-based example is managed volatility which can be expressed as encompassing a wide range of asset classes that employ a variety of tools including equities, fixed income, derivatives and other hedging securities. These things can provide security, returns and better income.
Portfolio Building Blocks
Over the past few years, many investors have included low-volatility equity strategies as building blocks to a diversified portfolio. The main considerations are to lower the exposure to equity risk, lessened the susceptibility to large intra-month drawdown; and the freedom they provide to investors to take on more risk elsewhere in their respective portfolio.
They are less core allocations than complimentary ones. Managed volatility is not the first strategy clients would likely to invest in, but they can be as vital to achieve their long-term goals as anything else in the portfolio.
Reduction Correlation and Increase Diversification
In today’s markets that are often driven by macroeconomic concerns instead of stock fundamentals, this resulted in the increased correlations between asset classes which heavily reduced diversification benefits. Low-volatility stocks have been seen as less correlated with other equity asset classes. Hence, they can help increase the diversification cap-weighted equity returns. This is basically important during a significant market drawdown when correlations among traditional equity classes have surged.
Strategies that focus on dividend-paying stocks also can help in providing advantages over similar products by providing a strong yield components. They can provide a more attractive alternative to the present low-yielding bonds by generating income at the same time offer an upside equity-market participation.
Although relevant in high-volatility, managed volatility, low-return environments and managed volatility are hardly new. These strategies provide flexibility for investors in looking to achieve specific objectives within their respective portfolios, apart from the investment environment.
Drawbacks and difficulties
Aside from low-beta and dividend paying stocks, there are many approaches to managed volatility: option-based tail risk strategies; dynamic allocation strategies such as constant portfolio insurance (CPPI); or the addition of new alternatives with low correlation to existing portfolio. Variations are wide, manager-to-manager and fund-to-fund. Investors should tread carefully in taking care of their selections.
There is a perception that most defensively-managed volatility products offer income and reduced volatility at the expense of upside potential, investors may anticipate nominal returns to toll benchmarks in long bull market runs since the same are effectively being traded upside for risk management.
It is imperative to recognise that while managed volatility strategies may not go as high as during sustained bull runs, they may not go down as much during market corrections. This simply means that they have less room to make-up when markets go soft.
Outpacing the recent market downturn
The benefits of using these strategies can quickly become obvious on days and weeks when markets make a decisive turn for the worse. The recent volatility the markets are currently experiencing provided analysts a definitive analysis on how strategies can perform during downturns.
While past performance is never a guarantee of future results, an analysis of the performance of managed volatility strategies is indicative of such presentation.
While the S&P 500 declined 3.68 %, 88 % of the publicly available U.S. managed volatility funds were able to beat the benchmark; the median being in excess of the total return was 1.40 %.
Despite the dramatic negative market movement, the S&P 500 finished the month up 2.44 % and investors were able to managed volatility funds enjoyed upside market performance, while avoiding a near disaster dramatic decline.
The value in managed volatility comes from possibly getting equity-like exposure with identical returns, lower volatility and better downside performance. Some funds provide regular dividend income and there is this expectation that in long bull markets, nominal returns would hinder the broader market. However, this does not fully encompass the other benefits these strategies provide.
Finally, it’s all about the risk. Adding managed volatility strategies to s client’s portfolio can result in better overall risk/reward characteristics than that of a fixed income and traditional equity. Along with providing ample liquidity and investment flexibility, these can be exceptional solutions for investors seeking consistent risk/reward profiles over the long term.