Remastering Volatility: Reducing Noise in Equity Allocations
 

What You Need to Know

Volatility is a challenge that has vexed equity investors for decades and has been amplified in today’s low interest-rate environment. As many investors reach for higher-return assets to help meet future obligations, they are likely to be more exposed to the higher inherent volatility that stocks add to an allocation. In this paper, we examine the root causes of volatility to provide a holistic perspective on risk-management solutions for the current complex environment. Distinguishing between market risk, factor risk and stock-specific risk can help investors identify the most appropriate strategic solutions to combat volatility and ensure that they are compensated for the risk in their equity portfolios.

MSCI ACWI volatility, 1H 2019

nearly double 2017 level

Stock volatility of companies

with the most unstable cash flows

Increase in volatility

high-leverage companies
vs. low-leverage companies

In the fourth quarter of 2018, many equity investors had good reason to feel anxious. Stocks were falling sharply, and by late December, US and global equities had tumbled by 20% and 17% from their respective September peaks. News headlines warned of recession and an imminent bear market. Amid the noise, it may even have seemed sensible to reduce or exit an allocation to stocks.

Those who did would regret the decision just a few months later. By the beginning of the second quarter in 2019, stock markets had recovered their losses from the fourth quarter of 2018. Despite the renewed confidence, many investors still feared the potential for further uncertainty to derail future returns. Even in a rising market, the anxiety caused by large market swings is very unsettling and may even cost investors money if they feel compelled to act in the midst of short-term events.

In this paper, we aim to provide a holistic perspective on a challenge that has vexed investors for decades: managing volatility in equity portfolios. By examining the root causes of volatility, we aim to provide a broader perspective on risk-management solutions for today’s complex environment. Distinguishing between market risk, factor risk and stock-specific risk can help investors identify the most appropriate strategic solutions to combat volatility and ensure that they are compensated for the risk in their equity portfolios.

Staying Invested Through Bouts of Turbulence

Equity market turbulence is nothing new. During the 10-year bull run since the end of the global financial crisis in early 2009, markets have been especially calm for prolonged periods because of the easy-money policies of central banks. The MSCI ACWI posted volatility of 5% in 2017, capping a six-year period of below-average volatility. The following year, volatility jumped to 11% (Display). Persistent volatility is widely expected in the years ahead because of the potential slowing of the economy, uncertainty over interest rates and monetary policy, and heightened political risks.

By identifying the sources of volatility, active managers can improve an investing experience and help investors stay in the market through bouts of turbulence. Reducing the noise that interferes with an investing plan is the key to remastering portfolios and realizing the benefits of long-term equity returns.

Display

Past performance, historical and current analyses, and expectations do not guarantee future results. There can be no assurance that any investment objectives will be achieved. The information contained here reflects the views of AllianceBernstein L.P. or its affiliates and sources it believes are reliable as of the date of this publication. AllianceBernstein L.P. makes no representations or warranties concerning the accuracy of any data. There is no guarantee that any projection, forecast or opinion in this material will be realized. Past performance does not guarantee future results. The views expressed here may change at any time after the date of this publication. This document is for informational purposes only and does not constitute investment advice. AllianceBernstein L.P. does not provide tax, legal or accounting advice. It does not take an investor’s personal investment objectives or financial situation into account; investors should discuss their individual circumstances with appropriate professionals before making any decisions. This information should not be construed as sales or marketing material or an offer or solicitation for the purchase or sale of any financial instrument, product or service sponsored by AB or its affiliates.

The views expressed herein do not constitute research, investment advice, or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams.

MSCI makes no express or implied warranties or representations, and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices or any securities or financial products. This report is not approved, reviewed or produced by MSCI.

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