Can investors take advantage of heightened market volatility to generate returns in 2020? David Schofield, President of Intech’s international division (based in London), gives his thoughts on the prospects for Intech’s strategies over the next few months.
- Higher market volatility is likely to persist in 2020, given heightened geopolitical uncertainty and the current level of economic ambiguity.
- Stock volatility is not a fleeting anomaly; rather it is an enduring, fundamental characteristic of all stock markets.
- Intech has introduced risk controls to manage incidental factor exposures, which are expected to increase focus on stock-specific risk rather than factor and sector exposures across the strategies.
Where do you see the most important opportunities and risks within your area of specialism in 2020?
Intech’s key area of expertise lies in understanding and using stock volatility, both as a source of return and as a means of risk control when building equity portfolios. As global equity markets continue to rise, we have seen a return of volatility throughout 2019 and expect volatility to persist into 2020. The ongoing heightened levels of geopolitical uncertainty, especially around Brexit and the US election process, and economic ambiguity, in particular with regard to the future direction of interest rates around the world, are two obvious reasons for this.
This scenario represents a clear opportunity for Intech’s process to harness this volatility in the form of an excess return by regular portfolio rebalancing, which relies on stock price volatility to generate a trading profit. But it is also clearly a risk for equity portfolios in general as the long-running bull market becomes increasingly vulnerable. We would suggest taking steps to increase the resilience of equity allocations by shifting to a more defensive stance through the adoption of Low or Adaptive Volatility strategies. Such strategies allow for protection on the downside in the event of a market reversal; but can still participate in the upside should the market continue to grind ahead.
Are there key themes that are particularly relevant to your strategy?
Intech’s strategies attempt to exploit volatility as a source of return, so the very existence of volatility itself, whether it comes from macroeconomic events, company results or political developments, is the most relevant theme. The good news is that there will always be some degree of volatility in stock prices, as investors buy or sell based on their interpretation of news and events, and according to their own needs, beliefs and investment objectives. Stock volatility is not a fleeting anomaly, here today, gone tomorrow; rather it is an enduring, basic characteristic of all stock markets. Intech can make use of this phenomenon as an ever-present, repeatable and sustainable source of potential return regardless of which particular fundamental themes happen to be driving the market at a given point in time. They are all just sources of volatility after all!
How have your experiences in 2019 shifted your approach or outlook for 2020?
One of the great strengths of Intech’s approach to equity management is the dynamic way that the process automatically adapts to changing market conditions, to better balance the prevailing and ever-changing trade-offs between risk and return. Tapping into the different sources of volatility and controlling the associated risks is at the heart of what we do. Better understanding of these sources of volatility should lead to better outcomes. One particular trend that continues is the increased focus on and use of factor investing by investors, both institutional and retail. This has led to an increased frequency and magnitude of the impact, both positive and negative, associated with various factor returns. Intech is now able to regularly assess how these factors are compensated for, with regard to their diversification potential and active risk. As a result, Intech has introduced risk controls to manage incidental factor exposures, which are expected to provide greater consistency in our relative returns, and increase focus on stock-specific risk rather than factor and sector exposures in the portfolios.
Is there a particular ‘chart to watch’ as a key indicator for change in 2020?
The Intech Equity Market Stress Monitor is a collection of five metrics we believe represent reliable indicators of stress in different equity markets, based on our 30-year history of studying volatility:
Source: Intech, as at 31 December 2019. Chart reflects the percentile rank as of date shown for each dashboard component against available history for the index. The risk metrics presented are intended to be general in nature and do not constitute investment advice or recommendations by Intech. This information is provided for informational purposes only, and is not an offer or recommendation of any security or investment product, or a prediction of future results or events. It should not be used as the sole basis for investment decisions. There are numerous other factors related to the markets in general that should be considered before making any investment decision.
The five metrics are related to measures such as the degree of capital concentration in the market, the levels of correlation and dispersion of stock returns, the efficiency of the market’s current configuration, and the degree of skewness of market returns. We currently observe an increase in systematic risk related to the rise in correlation of returns across global markets, which suggests potential ‘groupthink’ and may indicate more upcoming volatility. Additionally, the index efficiency risk metric is currently declining in equity markets, which may offer investors the potential to improve diversification with less beta exposure.
We believe that all of these metrics, when viewed in aggregate, can be a good indicator of whether the market exhibits more stress than normal (and is therefore vulnerable to shocks), or if it is in a more relaxed state (and likely to be more stable). We find these indicators useful as a tool to enhance our own understanding of market conditions and hope you will too.