Avoid ‘volatility traps’ in stock selection
Strategies based on sacrificing some upside while reducing downside has helped Australian equity investors beat the market over the last three years, according to the asset manager AllianceBernstein (AB).
AB’s chief investment executive officer, Australian equities, Roy Maslen said that the AB Managed Volatility Equities Fund’s strategy was aimed to “smooth the ride for investors” in two ways. First, by ignoring benchmarks for the purposes of portfolio construction and, secondly, by allowing fund managers to select stocks that were likely to lose less when the market fell and would provide some upside when the market rose.
“If you want to fall less than a market you have to be different and deviate from the index,” he said.
Maslen explained that the fund on the whole would lose less on the downside which would mean it had less ground to make up when the market would rise again, with the AB Managed Volatility Equities Fund aiming to suffer 50 per cent of the downside when the market falls and to gain 80 per cent of the upside in a market recovery.
According to Maslen, investors should also “anchor the concept of stability” and although there were various ways to talk about it, including low volatility or low beta strategies, it would come down to the fact that investors would want to invest in companies with “strong, stable businesses” with their share prices being less volatile.
He stressed that this meant investors should pay attention to the companies that offered stability, quality and reasonable price. However, Maslen warned that when investors thought about owning the ‘quality company’, they often tended to concentrate too much on the company’s debt.
“When you’re thinking about owning the quality companies it’s not just those with less debt, much more important are those that are paying their debt down. When you are paying your debt down month in and month out that’s much more defensive,” he said.
Investors should be also cautious around ‘volatility trap’, understood as stocks that would show normally low volatility but with a tendency to sudden changes.
“We’ve done a lot of research in Australia, particularly over the last decade, about the companies that look stable and have attracted the quality characteristics and reasonable price but then something goes wrong, something changes, and the share price starts to fall. We would actually now say this is the volatility trap – something that looks stable and becomes a lot more volatile,” he said.
AB’s recently published research paper, “The Upside of Less Downside: How Defence Can Win in Australian Equities” capturing the Australian equities upside/downside strategies, would aim to educate advisers as there was a lack of understanding among financial advisers around downside protection strategies as advisers typically associated it with alternative investments and much more complex strategies.
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