Low-volatility strategies added value in a challenging year – and could be a useful approach to an uncertain year ahead.
Q: Mike, how did the year look from the point of view of a low-volatility investor?
A: 2016 was a year of booms, busts, global financial disturbances, macro issues like Brexit and the US election – in short, a very, very good time to be focused on low volatility, high dividend strategies.
Q: How so?
A: If you think back to the beginning of 2016 compared to today's environment, you’d think we were on a different planet. We were talking about global recession and the onset of another crisis. Markets were plunging, with the broad indices through mid-February declining, some over 10%.1 It reminded us during this period the importance of sector allocation -- even in this period of extreme fear, we saw significant dispersion across sectors. Through mid-February, you saw the value of defensive investing in quality sectors, things like utilities and telecoms actually posting positive numbers for that period, up about 5% or 6%, comparing that to financials which declined nearly 20% in that period. The VIX had risen over 60% and the sell-off was fairly broad-based on a global basis with both the US and emerging markets down over 10% and even developed international equity markets down over 13%.
That's in stark contrast to the remainder of the year – particularly since the election on November 8th. In the second part of the year, since the lows of February 11th, we saw a fairly broad market rebound of over 25%, until November 8th. We saw cyclicals rising over 20% in this period, outperforming defensives, particularly in the IT, financials, and energy sectors. We saw the VIX fall over 50%. Then after the election of President-elect Trump, you saw a very, very narrow market rally, with things like financials rocketing up almost 16.5% in that month-and-a-half time period before year's end.
Q: What about the impact of the post-election spike in yields, followed by the Fed rate hike in December?
A: We ran into a new sentiment environment post the November 8 election, where we saw a very sharp move in rates – you saw a 30% move in the 10-year yield – the largest rate spike since the “Taper Tantrum” of 2013. Our research has shown that in most kind of markets, low-vol types of strategies can keep up in rising rate environments – but a market in which rates rise steeply and quickly would be more of a challenge.
Q: What about developed markets outside the US?
A: A low-vol strategy, especially hedged against the U.S. dollar, can be a real advantage. Now as we approach record highs in the US, it’s an appropriate time to start thinking about broadening out equity exposure and diversifying into both developed international as well as emerging markets.
Q: So what does the year ahead look like for low-vol?
A: There’s certainly been a sentiment shift post-election where we really haven’t seen this type of exuberance about the equity markets or about potential for economic growth since the 2008 financial crisis, and that’s had a major impact on markets, to the point that many people are now questioning whether a low-volatility strategy makes sense going forward. We think they do. Both in terms of income and in terms of capital preservation.
Q: So capital preservation is a likely focus?
A: That's the way it seems to us. While there’s tons of positive sentiment in the market, we still see a significant amount of uncertainty despite people’s optimistic outlooks. One macroeconomic commentator has called 2017 the most uncertain year since World War II. Potential areas of disruption include, and just to name a few: policy disappointments at the length of time it takes to put new policies in place; China's leadership transition at the end of this year; major elections in both Germany and France which could call into question the entire European project. So we do expect volatility to very much continue – not counting the possibility that the Fed may have to start to raise rates quicker than they had anticipated if economic growth does indeed take off.
Q: Thanks, Mike.
A: My pleasure.