(April 17, 2012) — Is low-volatility investing a solution for asset owners concerned with matching plan liabilities while limiting volatility — or is it unrealistic?
Successful low-volatility investing strategies are rare, and must be done through conscious allocation decisions rather than by simply de-risking via more fixed-income, according to some attendees at aiCIO’s Chief Investment Officer New York Summit. “There are ways to smooth out returns, but in this market I don’t know if the expense always justifies the cost if done passively across the entire portfolio,” said Damon Krytzer, a trustee at the San Jose Police and Fire Retirement Plan and managing director of Waverly Advisors.
Krytzer noted that for a plan sponsor, moving down the efficient frontier is not possible in this market environment — one that is dominated by an attraction toward low-risk strategies. “You need to consider what your left-tail exposure is and try to be more tactical protecting against that while still having a high enough risk strategy to beat assumed return expectations,” Kytzer said.
The solution, according to Krytzer? A proactive strategy by focusing on portfolio exposure, hedging uncompensated or unintended risks deliberately.
Meanwhile, NEPC’s Erik Knutzen voiced a similarly wary sentiment over low-volatility investing. “Low-volatility stocks may be relatively overvalued in the current environment. There’s a danger when marketers are launching investment products because it looks good right now — but that may be the exactly the wrong time to be allocating. We agree that that’s a danger allocating to low-volatility equity,” he said.
He continued to note that in order for institutional investors to achieve returns comparable to the broad market indices with low-volatility strategies, they may need to apply leverage. “However, most clients aren’t comfortable with or capable of taking leverage, they view it as dangerous,” he said.
The bottom line, according to critics of low-volatility strategies: While a strictly low-volatility investing sounds wonderful — similar to world peace and the end of world hunger — it is often an unrealistic way to achieve assumed returns. It is not possible to successfully meet return assumptions by moving down the efficient frontier, they say. Instead, institutions must keep an eye and guard against left-tail exposure while seeking a high enough risk strategy to surpass assumed return expectations. Pursuers of low-volatiliy strategies thus must be aware of its shortcomings.
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