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US Conservative: lower valuations, higher payout

US Conservative: lower valuations, higher payout

23-01-2017 | Insight

Markets reacted positively to the election of Donald Trump, who took office last week. However, some investors may now realize they got ahead of themselves and brace for a rougher ride. Low-volatility stocks usually perform well in tougher markets, so our US Conservative Equities strategy might be an attractive option.

  • Jan Sytze  Mosselaar
    Jan Sytze
    Mosselaar
    CFA, Director, Portfolio Manager

Speed read

  • High valuations and an ageing bull market raise concerns
  • Low-volatility stocks tend to do well in turbulent times
  • Over ten-year proven track-record for Conservative Equities funds

Only a few days into Donald Trump’s term as the 45th president of the United States, US equity investors are still optimistic about economic prospects. After a slow start in 2016, the American economic recovery has regained momentum, propelling US stocks despite uncertainties raised by the mostly unexpected outcome of the presidential election.

The S&P 500 index is up more than 5% since election day while expected volatility, as measured by the VIX index, is again close to its lowest levels of the past decade. Market wobbles initially feared by some analysts prior to the vote have not materialized.

But as the bull market prepares to celebrate its eighth anniversary in March, valuation multiples are also looking increasingly stretched, fueling concerns over a potential end to the current uptrend and a return of volatility. In this context, the Robeco US Conservative Equities strategy can be seen as a good way to significantly reduce risk without hampering returns, says Jan Sytze Mosselaar, a portfolio manager of Robeco’s Conservative Equities team.

Since its inception in April 2014, the fund has delivered positive excess returns before costs, with a 15% lower volatility. This has resulted in a return/volatility (Sharpe) ratio of 1.8, compared to a 1.5 ratio for the benchmark.

‘Positive excess returns with a 15% lower volatility’

Moreover, “while this higher risk-adjusted return of the strategy is already remarkable, low-risk stocks could extend their lead if US equity markets entered a prolonged period of increased volatility,” says Mosselaar. This has actually been the case in European and Emerging stock markets over the past six years.

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An attractive portfolio

The Robeco US Conservative Equities strategy offers an attractive portfolio, both from a valuation and a payout standpoint. It also enables enhanced exposure to momentum and earnings revisions compared to either the MSCI North America or MSCI North America MinVol indices.

The portfolio’s current average 12 months trailing price/earnings (P/E) multiple stands close to 17.5, compared to 20.3 for MSCI North America and 22.3 for MSCI North America MinVol. “Despite the valuation gap between low-risk stocks and the rest of the market, our robust investment process still enables us to find attractively valued low-risk securities,” says Mosselaar.

Meanwhile, the portfolio’s payout yield, which takes into account both dividends and share buybacks, currently remains close to 4%, which is significantly higher than the 1.6% yield of the market index. Payout yield is important as it tends to represent a significant part of total equity returns over long periods of time.

Proven track record of reduced volatility

Robeco has long been a pioneer in low-risk investing. The US Conservative Equities strategy builds on our investment team’s extensive experience in selecting US low-volatility stocks with the Global Conservative Equity strategy, which was launched back in 2006.

Like our other products in the Conservative Equities range, this US-focused fund exploits the low-volatility anomaly. Low-beta stocks and low-volatility stocks tend to generate higher risk-adjusted returns than they should, according to the Capital Asset Pricing Model.

This anomaly was first documented for the US stock market back in the 1970s by prominent academics, such as Black-Jensen-Scholes (1972), Fama-MacBeth (1973) and Haugen-Heinz (1975). Robeco’s academic research has confirmed this and has also shown that the volatility effect is growing stronger in the European, Japanese and Emerging equity markets.

A new era dawns for the United States, but how long will it take newly inaugurated President Trump to change the course of the supertanker that is America? In a series of four articles we analyze the likely economic effects, and the effect on the US companies in which we invest.