Conservative Equities: strong risk reduction despite the recent value drag

Conservative Equities: strong risk reduction despite the recent value drag

02-12-2019 | Insight

Despite inevitable hiccups, Conservative Equities’ track record shows our approach adds value. Since inception, our flagship strategies have been able to beat both the market and generic low-risk products.

  • Jan Sytze  Mosselaar
    Jan Sytze
    Portfolio Manager

Speed read

  • Bumps are inevitable for an active low-risk, benchmark-agnostic strategy
  • Value tilt has been weighing down on performance in developed markets 
  • Long-term track record remains intact in emerging and developed markets

For over 13 years now, the Robeco Conservative Equities approach has proven able to deliver added value in both developed and emerging markets. Our flagship strategies in both categories have outperformed their two reference indices, the market index and the main minimum volatility index, gross of fees, as shown in Figure 1.

Figure 1 I Cumulative excess returns Developed and Emerging Conservative Equities (logarithmic scale)

Source: Robeco Performance Measurement. All figures gross of fees in EUR. In reality costs such as management fees and other costs are charged. These have a negative effect on the returns shown. The value of your investment may fluctuate. Results obtained in the past are no guarantee of future performance. Inception date Global Developed Conservative Equities is October 2006 and March 2011 for Robeco Emerging Conservative Equities. Optimization currency for MSCI World Minimum Volatility Index is EUR, and USD for the MSCI EM Minimum Volatility Index.

But it hasn’t all been smooth sailing. There have also been occasional bumps along the way, with periods of lagging performance. In other words, we won’t beat all the indices all the time. 

Such hiccups are inevitable for an active low-risk strategy that is benchmark-agnostic, unconstrained by tracking error limits, and characterized by a typical active share of 80% versus the market index and around 70% versus the minimum volatility index, as provided by MSCI. Moreover, weaker periods have always been followed by strong recovery, supporting the long-term track record.

Conservative Equities is an active low-risk strategy, aiming for long-term stable returns and a high income. Its diversified and actively positioned portfolio is created through a factor-based, bottom-up stock selection process and a straightforward portfolio construction process. The objective is to maximize the absolute return-risk ratio over a full performance cycle.

Value drag in developed markets

Currently, our Global Developed Conservative Equities strategy seems to be going through one of these rougher patches, in particular when compared to the MSCI World Minimum Volatility Index. Comparatively, the strategy’s performance relative to the MSCI World Index has been more consistent with expectations.

The main reason for the recent higher return for the minimum volatility index has been its bias towards low-risk stocks with a higher valuation, as expensive stocks outperformed cheap stocks. Conservative Equities has had, and still has, a valuation gap of around 20% versus the index, as it selects low-risk stocks with an attractive valuation, high pay-out yield and positive momentum.

Performance of Robeco Global Developed Conservative Equities strategy versus the MSCI World Minimum Volatility Index was especially weak in 2018. As a result, short-term performance of the strategy, up to five years, looks less strong relative to this specific index, while the long-term track record remains intact.

The situation is quite different in emerging markets, where the value factor has been a positive contributor to relative performance for our Emerging Conservative strategy over the last few years. In these markets, the strategy’s preference for low-risk, high-dividend emerging markets stocks has worked well, both versus the MSCI EM Index and MSCI EM Minimum Volatility Index.

Despite the recent value drag in developed markets, both strategies performed in line with expectations

Overall, however, despite the recent value drag in developed markets, both strategies performed in line with expectations. They lagged in strong bull markets, like in 2017 and during the periods of rising markets seen in 2018 and 2019. But they also delivered strong risk reduction in falling markets, like in February/March 2018, the last quarter of 2018, and in May and August 2019.

Valuation gap opportunity

Moreover, we see the current valuation gap between Conservative Equities and the MSCI Minimum Volatility indices as an opportunity for future outperformance in both developed and emerging markets. This is especially the case given the lower expected equity returns that Robeco projects for the next five years.1 

Over the last few years, most developed markets investors have focused on growth stocks that featured high earnings growth, regardless of valuations. This is not unusual behavior in a bullish, late-cycle phase of the market. But, as the market cycle matures, stocks with a high valuation and rapid earnings growth should lose some shine.

Dividend, capital protection, and reasonable valuation levels may in the meantime become more relevant again for investors, as they usually do in more difficult times. In such a scenario, we expect our focus on low-risk stocks with a high dividend yield and attractive valuation levels can show its added value once more, in both developed and emerging markets.

1See our latest ‘Expected Returns 2020-2024’ report for more details.

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