Rising rates mean it’s time to rethink low volatility

Active management key: Unigestion

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167304_roller_coasterIt might seem strange to hear a low-volatility equity manager say it’s a bad time for low-volatility stocks—but that’s exactly what we heard over lunch with managers from Swiss-based Unigestion, which recently opened a new Toronto office to serve its Canadian institutional clients.

Equity manager Alexei Jourovski, visiting Toronto from Geneva, explained that, while institutions have piled into low-volatility equity products over the last few years, rising interest rates are going to have a big impact on performance over the next few years. This fact became painfully obvious during last May’s taper tantrum, when former U.S. Federal Reserve Chief Ben Bernanke spooked the market by signalling that the central bank could start slowing its asset purchases sooner rather than later.

The spectre of rising rates put low-volatility indexes through the wringer: while the MSCI World Index dipped 2.4% between April 30 and June 30, 2013, the MSCI World Minimum Volatility Index and the S&P Developed Low Volatility Indexes dropped an eye-popping 4.5% and 9%, respectively.

So why did low-volatility indexes let investors down? According to Jourovski, stocks in a low-volatility index tend to be overpriced and suffer from crowding, with a few large investors holding large numbers of shares. That adds volatility, contrary to the label these stocks have earned over the last few years.

Rising rates and changes in low-volatility stocks mean investors need to consider new factors when it comes to identifying low-volatility stocks, particularly interest rate- sensitive macro factors such as sector and country and cyclical factors that can drive stock picking.

At the end of the day, low-volatility investing is becoming an active game, favouring low-volatility portfolios rather than passive indexes.

Private equity in a recovering Europe
Is it time to give Spain another chance? Very possibly, according to Christophe de Dardel, Unigestion’s director of private assets. At the same luncheon, de Dardel discussed opportunities in private equity for Europe as it moves ahead on the road to economic recovery. It’s time to take advantage of the re-emerging south, he said, noting that Spain in particular is poised for solid growth.

The north, by contrast, is more mature and stable, but it’s also becoming saturated by investors. He gave the example of Sweden, where the private equity market has become overcrowded and is now fully priced. While the economy is strong in Sweden, there are fewer opportunities for investors.

Spain, however, is re-emerging fast, despite the fact that investors have deserted the country. Deals are moderately priced, and the economy is on the path to recovery—and that means more investors will begin to flood in.

Country or pan-European?
How can investors best access European private equity? De Dardel pointed out that, while pan-European funds are well run, they tend to focus only on large buyouts, and investors are likely to miss out on the opportunities in France, Italy and Scandinavia.

Country funds are a better way to make the best out of a recovering Europe, noted de Dardel, and they offer investors an overwhelming choice of managers.

Investors would also do well to consider secondaries in the European private equity market. In fact, it’s a large part of the private equity market due to the limited numbers of large portfolios in Europe, the fragmented nature of its pension system and the fact that allocations to private equity are still small.

Secondary deals are an excellent way to make the most of European private equity.

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