A low-volatility portfolio can bring good returns without great risk, but building that kind of portfolio is not as simple as finding low-beta stocks. Investors need to be aware of risks and when they consider investing aboard, they need to understand whether they should engage in currency hedging.
Research on low volatility in various countries, including Canada, shows that the least risky stocks do not, on average, earn lower returns—and vice versa, said Ryan Taliaferro, senior vice-president and portfolio manager with Acadian Asset Management, speaking at Benefits Canada’s recent Benefits & Pension Summit in Toronto.
Jean Masson, managing director of TD Asset Management, echoed that sentiment. “There seems to be an absence of better returns for risk” except when the markets are very generous, Masson explained, speaking at the same event.
“Suddenly you think, if I’m going to get the same average returns by holding these low-volatility stocks, that begins to look attractive,” Taliaferro said, adding that a low-beta portfolio offers better compounding, too.
However, low-volatility portfolios can be accidentally exposed to certain risks. For example, depending on the sectors one is invested in, unintentional exposure to low interest rates can occur, he said, explaining that in different sectors, stocks produce different returns, depending on whether interest rates are falling or rising.
Another consideration when building a low-volatility portfolio is currency. When investors look at foreign equity markets, they should estimate risk from the viewpoint of their home currency—and depending on whether their currency is pro-cyclical, they should decide whether to hedge their currencies, Masson explained.
“The Canadian currency does well when equity markets do well; when times are bad, the Canadian dollar depreciates,” he said. Since the loonie is pro-cyclical, Canadian investors shouldn’t do currency hedging when they’re trying to minimize volatility, he advised. “You shouldn’t hedge unless you’re really good at telling where the Canadian dollar will go.”
However, investors whose home currency is anti-cyclical, such as Americans, do need to hedge in order to reduce risk, Masson added.
Also, he said, investors need to pay attention to valuations because it’s not advisable to load up on stocks that are too expensive.
All the articles from the event can be found on our special section: 2014 Benefits & Pension Summit Coverage.
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