What is driving the growth in low-volatility investing?

18-10-2012 | Insight

A long and successful track record, portfolios covering global, developed and emerging markets and a sophisticated quantitative investment process are propelling the take-up of Conservative Equities, says Arlette van Ditshuizen.

Arlette

van Ditshuizen

Senior Portfolio Manager

Q. The number of low-volatility options available has grown rapidly. Why invest in an enhanced low-volatility strategy, such as Robeco’s, instead of a generic alternative?

A. It is no wonder that the number of low-volatility options is growing. Investor interest is increasing and it is not too difficult for an asset manager to build a low-risk portfolio: just rank the universe based on volatility or some other statistical measure and select the top 20%.

Our ranking model, however, is much more sophisticated. We reduce risk by using a combination of variables and by including forward-looking measures based on a proprietary distress-risk model. Returns are enhanced by selecting low-volatility stocks which also have attractive valuation and sentiment characteristics.

If there are two stocks that are equally attractive in terms of low risk, we prefer the stock with the best valuation and sentiment. We like to say that no two low-risk stocks are created equal. One will likely have a better future return than the other—and that’s the stock we select for the portfolio.

Q. Are there any other advantages?

A. Enhanced low-volatility strategies, such as Robeco Conservative Equity, can overcome recognized pitfalls of low-volatility investing, such as exposure to unnecessary downside risk, high turnover in illiquid stocks and concentration risks. We have put a great deal of effort and research into our ranking model and portfolio construction tool. They are both based on years of experience in quantitative investing in general and low volatility investing in particular.

For example, we have learned over the years that taking a broad view of risk, which incorporates non-statistical measures such as distress risk, can enhance a low-volatility portfolio. We developed a proprietary distress risk model that takes into account how balance-sheet leverage might translate into future distress and which incorporates other forward-looking financial information about a company’s corporate structure. Our distress risk model improves overall performance by helping the portfolio to avoid tail risk and by reducing the severity and occurrence of drawdowns.

Q. How has the strategy grown over the years?

A. After we introduced the global portfolio in October 2006, it seemed natural to expand the Conservative strategy to other equity markets. In September 2007, we introduced the European portfolio and in February 2011, emerging markets. Investors should be aware that we are using the same proven model to select low-volatility stocks in each region. The same model factors are used in developed and emerging markets.

Q. What was behind the development of Emerging Conservative Equities?

A. When we launched Emerging Conservative Equities, we had already been running the developed markets strategy for about five years, and we were convinced of its ability to deliver market returns with less risk. We had also completed research that quantified the volatility effect in emerging markets and also showed that it was increasing over time.

The development of Emerging Conservative Equities was possible because of a unique combination of in-house experience in emerging markets equities, low volatility strategies and quant investing. We had, for example, been managing emerging markets quant portfolios since 2006. And Robeco’s fundamental Emerging Markets team had been investing in emerging markets since 1994 and using Robeco’s proprietary emerging-markets stock-selection model to generate ideas since 2001.

Q. How has performance been?

A. Since inception in February 2011, the Emerging Conservative Equities portfolio has generated an excellent track record with a 26% gross cumulative return versus 2% for the MSCI Emerging Markets Index, as of month-end September 2012. The Robeco portfolio’s return was also achieved with a risk reduction of more than 30%. Assets under management have grown unbelievably fast and are now above EUR 500 million.

Q. Why do you think the Robeco strategies continue to gain client assets?

A. I think our clients are attracted by our good performance across different markets. Our long track record also puts us at the “top of mind” among prospective clients. There are a number of different options to choose from, including generic minimum-volatility strategies, but one reason clients choose Robeco is because our performance is so much better than that of the reference index. We are not oriented toward any benchmark, but we are always pleased for our clients when our strategies show excess performance versus standard indices.

But, of course, performance is just part of the story. Many of our pension-fund clients are also responding to the uncertainty of the economic recovery and looking to harvest the equity risk premium at a lower volatility and to stabilize coverage ratios. They find the capital preservation aspect of the Conservative Equity strategy particularly attractive.

Q. Are clients willing to pay a premium for Conservative Equities compared to a generic index?

A. Yes, our clients are willing to pay a little bit more for Robeco’s low-volatility strategy. This is due to our long-term commitment to low-volatility investing, our research in the area and the integration of risk management into our strategy.

Clients appreciate that there is no “black box” with Robeco’s Conservative Equity portfolios. We can explain every position. Unlike many generic strategies, we are not just ranking stocks based on risk. We do more and it provides a more robust outcome. I think that’s why clients prefer our approach in today´s uncertain markets.

Q. What have you learned running Robeco’s Conservative Equity portfolios?

A. We were one of the first to offer a low-volatility equities portfolio and, from this vantage point, we were among the first to prove that the volatility effect can produce a market rate of return with less risk in practice. This was our premise when we started Conservative Equity, and I have always believed in it. Nonetheless, it is gratifying to see the proof that it works in our successful live track records. For clients who invested with us prior to the financial crisis, it is clear that reducing risk and limiting losses can have a huge effect on long-term returns.

Arlette van Ditshuizen is the co-portfolio manager, with Pim van Vliet, of Robeco’s Conservative Equity portfolios. Together they manage more than EUR 3 billion in low-volatility equities. Van Ditshuizen, who joined Robeco in 1997, has been managing Robeco´s Conservative Equities portfolios since February 2007, when she joined the Quantitative Equity team.

The value of your investments may fluctuate. Results obtained in the past are no guarantee for the future.

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