(February 21, 2012) — Investors should not rely on the value-focused section of their equity portfolios in a stressed market environment, a paper by Mercer Investment Consulting has suggested.
Low volatility assets should be incorporated to a global equity allocation, the consulting firm said, to level out other characteristics of a portfolio tapping long-term growth.
Dean Cheeseman, portfolio manager at Mercer, told aiCIO: “When markets are under stress, investors normally depend on value managers, but in 2011 this type of manager did not have a good year.
“Markets became so short-sighted that managers that were prepared to buy and hold saw that their strategy did not work, as markets rewarded in the short term instead.”
Cheeseman said that once an investor had bought in a global equity holding, including emerging markets and small-cap stocks, to take advantage of long-term growth, a portfolio needed balance from a low volatility section.
“Markets have oscillated so violently – meaning markets have had the opportunity to retrench – geopolitical noise has necessitated the need for a counterbalance,” he said.
The Mercer paper said changes in the investment landscape over market cycles has meant different sectors performed well at alternating times, so a portfolio should be constructed to be able to adapt to take advantage of these movements.
It said: “A simplistic policy of adding strategic tilts to emerging markets and small cap portfolios will increase both expected return and expected volatility. Therefore a global equity portfolio needs to adopt lower volatility characteristics without substantially compromising the expected returns.”
Mercer recently released a product with three distinct pillars incorporating this strategy; global equities, incorporating emerging markets and small-cap stocks, low volatile equity and quality portfolios.
Cheeseman said that back-tested over seven years, the strategy would have matched the MSCI World Index return, but with between 70-75% of the volatility.
However, he admitted that launching the product immediately before the third quarter sell-off of equity markets last year helped boost the strategy’s performance.