How can plan sponsors build a defensive portfolio to manage volatility? They may want to consider low-volatility equities, said Kristen Colvin, director of consultant relations for the United States at MFS Investment Management.
“We know that there are investment realities related to volatility,” Colvin told Benefits Canada’s DC Plan Summit in Montreal in February.
“Volatility can diminish the rate at which investments grow over the long term, low and negative returns inhibit the benefit of compounding and the sequence of returns experienced by members is critically important as account balances grow,” she added.
“It’s fair to say that volatility can also exacerbate certain behavioural biases, so we need to make sure that we’re controlling for that in terms of the investment options that we’re putting in front of our members.”
Video: The benefits of low-volatility equities
Colvin noted defined benefit plans have successfully used alternative investments to manage volatility. “For example, allocating to alternatives may reduce portfolio risk, lower correlations, provide the opportunity for absolute return and access to specialized skill and unique asset classes,” she said.
Colvin suggested there’s an alternative way to accomplish similar goals by considering an allocation to low-volatility equities involving publicly listed, highly liquid and transparent investments.
Low-volatility equities offer the potential for similar returns as a traditional equity portfolio but with lower risk and the potential for preservation of capital in down markets. Showing an illustration of global stocks according to volatility between January 1990 and December 2015, Colvin noted that the most volatile equities have actually underperformed those with the lowest volatility.
“Historically, low-volatility equities have offered a diversifying allocation and have outperformed during periods of market declines,” she said.
Given that equities represent a significant portion of defined contribution pension plan members’ allocations, reducing equity volatility can enhance returns and minimize behavioural tendencies, she added.