With the period of low-interest rates, low inflation, and low volatility seemingly in the rearview mirror, Portfolio Manager Brandon Smith, CFA, CAIA, explains how a value-oriented long/short equity strategy can potentially reduce volatility and create an opportunity for profit by separating the winners from the losers.
Catalysts in Play: Following a decade in which U.S. equities have compounded at more than 15% annually, with very low volatility, investors seem to have become more focused on return and less focused on risk and downside protection, which could be a costly oversight.
Entry Points: It appears that the regime of zero interest rates, low inflation, and an ever-expanding Federal Reserve balance sheet, with low equity volatility, is over. We firmly believe that the next 10 years are highly unlikely to resemble the previous decade in global equity markets. Thus, the prospects for long/short equity investing are promising.
Volatility Reduction to Preserve Capital: Volatility reduction is extremely important, as the laws of mathematics dictate that volatility will eat away at a compound return stream over time. Additionally, volatility can lead to behavioral pitfalls such as loss aversion, causing investors to sell out of equities at inopportune times, further compounding a loss.
Win-by-Not-Losing Approach: A tried-and-true adage holds that if one loses 50% one year, she or he will need to make a return of 100% the next year to break even. In this video, we demonstrate how, with a simple average return of 7% annually, increased volatility leads to lower compound average returns in six different illustrative examples.
Active Strategy: Value-focused long/short equity strategies can help investors weather periods of high volatility by reducing the loss of capital and creating the potential for profit by separating winners from losers. Disciplined execution of a bottom-up, value-driven investment approach – incorporating both quantitative analysis and fundamental research – can help help investors potentially stay ahead of changing market conditions.
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Statistics and other information taken from the following sources:
Volatility – In finance, volatility is the degree of variation of a trading price series over time, usually measured by the standard deviation of logarithmic returns. Historic volatility
measures a time series of past market prices.
Federal Reserve – The Federal Reserve System is the central banking system of the United States of America. It was created on December 23, 1913, with the enactment of the Federal
Reserve Act, after a series of fi nancial panics led to the desire for central control of the monetary system in order to alleviate fi nancial crises.
Compound returns – Compound return is the rate of return that represents the cumulative effect that a series of gains or losses has on an amount of capital over time.
Loss aversion – Loss aversion is the tendency to prefer avoiding losses to acquiring equivalent gains. The principle is prominent in the domain of economics. What distinguishes loss
aversion from risk aversion is that the utility of a monetary payoff depends on what was previously experienced or was expected to happen.
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Index returns are provided for comparison purposes only to show a broad-based index of securities, as the indices do not have costs, fees, or other expenses associated with their performance. In addition, securities held in either index may not be similar to securities held in the firm’s accounts. The trademarks and service marks referenced herein are the property of their respective owners. Third party data providers make no warranties or representations of any kind relating to the accuracy, completeness or timeliness of the data and have no liability for damages of any kind relating to the use of such data. Past performance is not an indication of future results. This document is not an offering of securities nor is it intended to provide investment advice. It is intended for information purposes only.
The views expressed in this video reflect those of Boston Partners as of the date of this video. Any such views are subject to change at any time based on market and other conditions and Boston Partners disclaims any responsibility to update such views. Discussions of market returns and trends are not intended to be a forecast of future events or returns.
Estimates reflect subjective judgments and assumptions. There can be no assurance that developments will transpire as forecasted and that the estimates are accurate.
Equity securities are volatile and can decline significantly in response to broad market and economic conditions.