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‘Back to normal’ means a new dawn for defensive equity investors

‘Back to normal’ means a new dawn for defensive equity investors

17-10-2022 | Insight
After three consecutive years of double-digit returns, we’re heading into a new but familiar environment of uncertainty. The Global Conservative Equities strategy is a safer bet for investors who want to position themselves more defensively.
  • Jan Sytze  Mosselaar
    Jan Sytze
    Mosselaar
    Portfolio Manager

Speed read

  • Investment environment is ‘returning’ to new levels of uncertainty
  • Conservative Equities typically thrives in moderate, volatile market environments
  • Stable, solid stocks trading at attractive valuations and good dividends

After the ‘warm bath’ of an ultra-loose three-year period of double-digit returns, investors now clearly find themselves being buffeted by a sudden cold shower of headwinds. Yields have risen from ultra-low levels, inflation is no longer anchored, and central banks are reversing their multi-year accommodative stance. We believe these headwinds are likely to persist for the foreseeable future, meaning equity markets will essentially go ‘back to normal’ and show more modest returns and occasional periods of high volatility going forward.

With bond markets having failed to provide a safe alternative this year, given the path to normality for interest rates around the world, it’s worth remembering therefore that in uncertain environments, low-risk strategies tend to perform better. This includes winning by losing less. In particular, history shows us that the relative performance of the Global Conservative Equities strategy is typically good in this market environment.

A brief foray into historical volatility

In the table below, we can track the performance the strategy in three periods of five years each, starting with inception, which shows us how the strategy did in times of historical volatility.

Table 1 I Summary of the three five-year periods, current period and totals

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. Source: Robeco Performance Measurement. Track record is unhedged for the entire period. Before July 2012 the portfolio was hedged into EUR, presented returns are unhedged for better comparison. Period 4 is too short to calculate a meaningful beta and therefore alpha.

In its first five-year period, an initially calm and complacent market was rocked by the largest global financial crisis since the 1930s Great Depression. In this volatile period, Global Conservative Equities showed strong risk reduction in 2008, leading to a positive alpha, despite the strategy lagging in the 2009 recovery. This period also includes the first two volatile episodes of the European sovereign debt crisis, again leading to lower losses for the strategy. The first five years were relatively successful for the strategy, avoiding losses while the market dropped an annualized 4.16% per year.

In the second five-year period, the European debt crisis took center stage and many feared a second global financial crisis based on bad debt. Nevertheless, markets churned out annualized double-digit returns, despite periods of high volatility, and it turned out to be a successful period for equity investors and for the Global Conservative Equities strategy. While the MSCI World rose on average 15.7% per year (10.8% in local terms), the strategy managed to show an even higher return, against lower risk. Also the first half of 2016 was a good period for the strategy, but in July 2016, everything changed as a new market regime was clearly on its way.

The third period, however, was characterized by a calm and prolonged bull market. This was sparked by phenomenal returns for US tech stocks, especially FAANG; a trend which was magnified by the pandemic which accelerated digital trends dramatically. In this Goldilocks scenario of high returns and low volatility, Global Conservative Equities lagged the bullish market, especially in the strong recovery in Q2-Q4 2020, following the pandemic panic in Q1 2020. We want to emphasize though that the strategy’s alpha in this period was positive up until the start of the pandemic, when the strategy, for the first time since inception, did not provide the risk reduction one might expect.

Leaning into current and future volatility

Since the fourth quarter of 2021, market patterns have changed. Defensive stocks have stopped lagging the market, and the high market volatility in the first nine months of 2022 led to good relative returns for the low-risk factor. We believe this normalized market environment, with yields up and a reversal of the multi-year ultra-loose monetary policies, bodes well for the future of Global Conservative Equities.

This is because, as we’ve seen, although negative market returns are bad news for equity investors, conservative stocks tend to do relatively well in a volatile market environment. In the figure below, we show how Global Conservative Equities fared in this year’s and previous sell-offs (returns in EUR).1 Over the past eight major market corrections the strategy was able to reduce the market drawdown by an average of 31%, varying across different types of sell-offs.2 We see the same patterns for our EM and European strategy.3

Figure 1 I The strategy achieved risk reduction in most major sell-offs since inception

All figures gross of fees in EUR, as of 31 August 2022. In reality, costs such as management fees and other costs are charged. These have a negative effect on the returns shown. Track record is unhedged for the entire period. Before July 2012 the portfolio was hedged into EUR, presented returns are unhedged for better comparison. GFC 1 2007 = first episode of Global Financial Crisis from 12 Oct 2007 to 15 Mar 2008; GFC 2 2008 = second episode, from 25 Jun 2008 to 9 Mar 2009; EDC 1 2010 = first episode of European Debt Crisis from 23 Apr 2010 to 2 Jul 2010 ; EDC 2 2011 = second episode, from 2 May 2011 t0 3 Oct 2011; China, Greece 2015 = market turmoil in 2015 from 5 Aug 2015 to 29 Sep 2015. Growth scare 2018 = sell-off from 3 Oct 2018 to 25 Dec 2018; Pandemic panic = sell-off from 19 Feb 2020 to 23 Mar 2020; Inflation, war 2022 = sell-off from 4 Jan 2022 to 20 Jun 2022; Recession fears 2022 = sell-off from 25 Aug 2022 to 30 Sep 2022. The value of your investment may fluctuate. Results obtained in the past are no guarantee of future performance. Source: Robeco Performance Measurement.
Despite the recent outperformance, conservative stocks still trade at a discount versus the market, and still offer a decent payout yield (dividend plus net buyback yield), as the figure below shows. Especially our emerging markets strategy trades at a low price/earnings multiple and an attractive yield. So not only low-risk investors, but also value investors can position their portfolio more defensively with Conservative Equities.

Figure 2: Price/earnings and payout yield main Conservative strategies vs reference index

Source: Robeco, FactSet. Both indicators are trailing 12M. As of 31 August 2022.

Stable, solid stocks trading at attractive valuations and good dividend yields

In this brief insight, we highlighted how market circumstances have changed and how the Global Conservative Equities strategy is a suitable investment concept for investors that want to position themselves more defensively. We believe that investors will face a far more challenging market environment in the next few years, contrary to the joyful decade of double-digit returns.

Given that several tailwinds for investors have died down and the Goldilocks environment has changed into a colder investor sentiment, we expect the strategy to perform well in a more moderate, volatile world for asset prices. Moreover, the modest valuation levels for our strategies create a return buffer for our clients for the foreseeable future, in our eyes.

1Because of the strong USD/weak EUR, index and fund returns are less negative/higher in EUR terms than in local or USD terms.
2A notable exception was the pandemic panic, when several low-risk stocks were hit by the specific impact of the lockdowns, while high-beta tech stocks turned out to be the best defense. Apart from this exceptional period, the strategy has a strong track record of risk reduction in down markets.
3See for example our recent client note “Celebrating 15 years of European Conservative: higher returns against lower risks”, Jan Sytze Mosselaar, September 2022. European Conservative Equities managed to show risk reduction in the pandemic panic as tech is a small part of the MSCI Europe.

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