Susanne Willumsen of Lazard Asset Management explains why lower volatility equities do not equal lower returns. In fact, quite the opposite can be true.
Two keys to its success are not hugging cap-weighted benchmarks, and limiting losses in falling markets. When global shares slumped 27.6% in 2002 (GBP terms), simulations of Lazard’s fund dropped 9.7%. In 2008, it rose 1.6% while shares lost 17.9%, followed by a 15.7% gain as markets dropped 2.6%.
It might not outrun a bull market, she says, but it may not lag far behind it. It matched 2010’s 15.3% GBP rise and, by not following the market’s risk-on, risk-off pattern it did so with significantly less volatility. Willumsen notes following cap-weighted benchmarks such as MSCI World means accepting high weightings in volatile financials, for example.
“Instead, we find low risk, low-volatility defensive portfolios which might not participate as much in rising markets, but defend in falling markets.
“Simple cap-weighted equities benchmarks are quite a risky proposition in themselves, prone to risk concentration whether in financials or TMT, and these concentrations tend to form bubbles which have the potential to spectacularly blow up, which causes a lot of volatility in the benchmark.”
Willumsen says managers cluster around benchmark weightings not just because managers’ pay is typically measured relative to the benchmark.
“It is because managers are rewarded based on information ratios – not only -benchmark relative returns, but also relative tracking error to get there, so there is a very big disincentive to go into low-risk stocks, but the instinct is to chase risk.
“If managers do buy low beta stocks their tracking error increases, which is a negative incentive. Because markets rise over time there is much more incentive to take on more risk.”
She says the average beta of 300 global equities managers is commonly above 1. “About 75% if all global managers operate within +/-2% of the volatility of the cap-weighted benchmark.”