Is it time for the low volatility factor portfolio?

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Worries over unusually low market volatility are on everyone’s mind, and Christiaan Kraan, Paris-based investment specialist at Seeyond, says his firm puts a volatility screen above all other metrics when selecting and managing portfolio positions.

“Volatility, as a measure of risk, is very stable. A low-risk stock generally does not become a high-risk stock overnight,” he told FSA on a visit in Hong Kong.

Seeyond, which is an affiliate of Natixis Global Asset Management, makes use of quantitative models in their portfolios to provide low volatility products to clients, according to Kraan.

The firm’s products are in the smart-beta or factor-investing space, Kraan said, noting that they are still actively-managed, unlike the more popular smart-beta exchange-traded funds.

He said that Seeyond’s portfolios are different from traditional fund portfolios that are managed according to earnings, valuations and the macro environment.

“The issue is, it is very difficult to project the earnings growth of a company. It is also very difficult to foresee the next economic crisis or the macro events that are going to happen. Valuations can be high and they still continue to grow, and people have been worried about valuations for a long time.”

When selecting stocks for the portfolio, Seeyond makes use of a proprietary model that focuses primarily on measuring the volatility and the correlation of individual stocks, Kraan said, though he declined to elaborate on the emphasis the model puts on other metrics.

Watching drawdowns

One benefit of investing in low-volatility portfolios is that drawdowns tend to be lower than traditional portfolios, Kraan said.

“It makes sense that if you want to invest in equities, you want to do it in a solution that takes low risk, which could reduce your drawdowns, especially during crisis periods.”

He also claimed that through Seeyond’s models, the firm’s portfolios have an active share of 80%-90%, avoiding close replication of the benchmark.

Examples of low volatility stocks that represent diversified positions are telecommunications and dividend-paying utilities stocks in Asia, some retail banks in Asia ex-Japan, consumer discretionary stocks in Japan and industrial companies in Europe.

Sell signals are automatically executed. A position is reduced or removed when it “stops behaving like it should”, meaning it defies the expected direction. For example, a company’s stock price would abruptly move if M&A or a corporate restructuring were announced.

“If something is being taken over or restructured, its risk indicators are not going to be stable anymore. That’s why we remove stocks that lose or gain 10% in a day,” he said, noting that this falls under the active part of managing the portfolio.

The firm rebalances its portfolios three-four times per year, Kraan said, noting that during the last 12 months, their portfolios were rebalanced only twice given the low volatility environment.

Smart beta and risk

Smart-beta products are slowly getting popular in the region, although there are still concerns about how these products are built, Joel Coverdale, Hong Kong-based managing director for Asia-Pacific at risk management firm Axioma, told FSA in a previous interview.

If smart beta focuses on a particular factor, some of the assets in the portfolio may have characteristics that are driving returns that the manager is not looking at.

“You might choose the top 20 low volatility stocks [and the majority of them] might be banks, because banks may happen to be low volatility at the moment. But, am I taking on a bank risk or a low volatility risk? If they are Chinese banks, am I taking a country risk?”

Despite Coverdale’s reservations, he finds that smart-beta strategies could offer investors more sophisticated exposure while providing portfolio diversification.

The three-year cumulative performance of one of the firm’s funds, the Seeyond Global Minvariance H-I/A Fund, which is a global equity fund and managed by Juan-Sebastian Caicedo and Nicolas Just, versus its reference index. The fund’s three-year annualised volatility is 10.84, while the index is 11.48.

Source: FE. In US dollars

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