Managed volatility equity strategies, already gaining institutional investor interest this year, will get an extra lift from the stock market's recent fireworks, some money management executives and investment consultants say.
Executives with quantitative firms offering portfolios of relatively low-beta stocks — in pursuit of equal or better returns than a broader index can deliver with only a fraction of the volatility — cited signs of growing acceptance for those strategies this year even before the market's latest drama.
For example, at their annual client conferences in April, Russell Investments, Seattle, and Wilshire Associates Inc., Santa Monica, Calif., joined the ranks of investment consultants recommending that institutional investors consider managed volatility strategies.
Until now, investors in Europe, Japan and Australia have led the way in allocating money to managed-volatility strategies. For example, in April, Blue Sky Group, the fiduciary manager of KLM Royal Dutch Airlines' e13.8 billion ($20 billion) pension funds, allocated e125 million each to two low-volatility strategies, with plans to add to that total by the end of this year, noted Ramon Tol, Blue Sky fund manager-equities.
Some observers say the strategies are gaining traction globally this year.
The pension fund community “doesn't leap on bandwagons,” and the fact that the strategy isn't a neat fit for the way institutional investors currently construct their equity portfolios is a hurdle, noted Bob Collie, chief research strategist, Americas institutional, with Russell Investments. Still, the steady growth in interest since the first managed volatility strategies came out about six years ago has accelerated in 2011, and the latest market volatility could provide a further fillip, he said.
“I think this is real,” agreed Terry Dennison, Los Angeles-based director of consulting for Mercer LLC's U.S. investment consulting business. Low volatility won't replace traditional strategies, “but use of low-vol as a component of a well-structured portfolio, perhaps with allocations managed somewhat dynamically, will become mainstream,” he predicted.
Wild stock price fluctuations following Washington's Aug. 2 debt-ceiling deal, punctuated by five trading sessions where the S&P 500 index either plunged or surged by 5%, have provided a “perfect test case” for what managed volatility strategies can offer, noted Harindra de Silva, president of Analytic.
For the first two weeks of August, Analytic's $1.3 billion U.S. Low Volatility Equity strategy dropped 5.8%, while its benchmark Russell 1000 index tumbled 9.4%, Mr. de Silva noted.
Low-beta portfolios outperform more when markets fall than they trail when markets rally, resulting in superior compounded returns over the long term, he said.
William E. Jacques, executive vice president and chief investment officer with Boston-based Martingale Asset Management LP, said for the first two weeks of August, his firm's $325 million Low Volatility Large Cap strategy was 2.8 percentage points ahead of its Russell 1000 benchmark. “If you look at the five days the market was up, our product captured 85% of the gains; on the six down days, we were down only 74% of the market decline,” he said.
Acadian Asset Management's suite of global and emerging markets managed volatility strategies, with combined assets of $1.6 billion, have likewise outperformed their benchmarks by roughly 500 basis points or more between July 25 and Aug. 15, said Ross Dowd, senior vice president and head of global marketing with the Boston-based quantitative firm.
And while investors in Europe, Japan and Australia may have led the way until now, there are signs in the latest uptick in search activity that managed volatility is gaining traction in the U.S. as well, said Mr. Dowd.
Opinion remains divided on how big a boost managed volatility and low-volatility strategies will get from the market's latest hysterics.
Jennifer Young, president and co-CEO of West Palm Beach, Fla.-based INTECH Investment Management LLC, said that boost could be considerable, against the backdrop of institutional investors now struggling to garner needed returns while reducing volatility. She said INTECH is looking to launch a suite of low-volatility strategies in October.
Martingale's Mr. Jacques agreed, noting that the choppy nature of recent markets is providing a far more attractive environment for low volatility than a market plunge would have. “The phone has been ringing off the hook,” he said.
Acadian's Mr. Dowd said the latest evidence that managed volatility can deliver superior results in ugly market environments should leave the strategy on a growing number of institutional investor radar screens. He said within five years, Acadian's managed volatility assets could grow to $10 billion, roughly five times the current level.
Andrew Junkin, a managing director with Wilshire, was more measured. Interest will definitely pick up, but progress should remain “incremental,” amid continued educational interest from boards and investment committees, he predicted.
Firms with managed volatility products report healthy inflows year to date. Executives with Analytic, Acadian and Martingale report inflows of more than $500 million, $440 million and $275 million respectively this year.
Still, a number of investment consultants and investors say they're looking for further research to show that low- or managed-volatility strategies are mining a real market anomaly that can be consistently exploited.
Andrew Sawyer, CIO of the $10.8 billion Maine Public Employees Retirement System, Augusta, said, “I am considering low-volatility strategies as an alternative to cap-weighted indexes, but at this point Maine is more focused on establishing a strong theoretical basis for expecting an improved reward-risk tradeoff, rather than on evidence the strategy worked well for a specific time period or a specific market environment.”
