As a senior vice president and client portfolio manager at INTECH, Richard Yasenchak spends a lot of his time fielding highly technical investing questions from all manner of institutional investors.
Yasenchak recently sat down with PLANADVISER to discuss the issues he is hearing about most from institutional investor clients heading into the second half of 2016. He says there is clearly a strong focus developing around “low volatility” and “managed volatility” products, even as investors are still coming to a better understanding of what these terms actually mean when it comes to building high-quality portfolios.
“There’s no question that we are seeing our most significant growth in mandates aimed at reducing uncompensated risk for long-term equity investors,” Yasenchak says. “The growth in the space has been pretty remarkable, but it’s not at all surprising given the way the markets have behaved in the last year or longer. We are clearly moving into a higher-risk regime where reliable returns are harder to come by.”
The wider economic reality of dampened returns and increased volatility is having a direct impact on the way large institutional investors think about protecting their assets and portfolios. Given that INTECH is a provider of quantitatively driven low volatility and managed volatility products, it’s no surprise Yasenchak is fielding a lot of questions in this area.
“The clear interest in managed volatility and low volatility really cuts across our global client base,” he adds. “We are getting questions all the time about volatility management from large public and corporate pension plans, for example, and we are even seeing some building interest from large private defined contribution (DC) programs.”
When talking about “low volatility products,” Yasenchak is referring to portfolios that “specifically seek benchmark-like returns, over the full market cycle, with a total volatility, measured as the standard deviation, falling considerably below that of the index.” At INTECH, such products are generally built around the philosophy that purely capitalization-weighted indexes are not efficient and can be improved upon by varying portfolio weights based on the volatilities and correlations of stocks within the portfolio.
“These products are also built on the belief that positive excess returns can be achieved over the long term using estimates of volatilities and correlations, through systematic rebalancing that shifts the portfolio exposures over time to take into account the overall level of risk currently in the market,” Tasenchak says. “It all comes down to mitigating uncompensated risk.”
NEXT: When managed volatility makes the most sense
According to Yasenchak, “managed volatility” and “low volatility” portfolios are ultimately trying to take into account the fact that, when risk surges in the market, “the old adage that you must have risk to have reward breaks down.”
“Of course it’s true that you cannot generate returns over the long-term without taking on some measure of investment risk,” he notes, “but this does not mean that all the risk you are taking over time is being compensated equally. Right now there is a building consensus that there is less potential return out there in the markets, while at the same time the risk is increasing substantially. While we are not making forward-looking performance predictions, this fact should still inform our portfolio allocation decisions.”
“Managed volatility” products are built essentially around the same ideas, but such funds generally seek to outperform their index over the full market cycle, while still pursuing total volatility below that of the index. “Again, this investing philosophy is built around the idea that capitalization-weighted indexes are not wholly efficient and can be improved upon by varying portfolio weights based on the volatilities and correlations of stocks,” Yasenchak says. “At INTECH, we rely on algorithms and automation to generate portfolio recommendations that we believe can outperform while offering additional protection on the downside.”
Breaking these ideas down further, he observes that managed volatility and low volatility products, at the heart, are aimed at helping investors achieve a greater sense of security while still holding on to their equity exposures.
“Compared with other approaches, I think low and managed volatility strategies make a lot of sense right now,” Yasenchak concludes. “Fixed-income yields remain at historic lows, so any reduction in the commitment to equities will almost certainly have a corresponding reduction a client’s expected portfolio returns. This is unacceptable given everything we know about the retirement shortfall. Low volatility and managed volatility equity can offer up an answer.”