Market Perspectives


Kevin: Hi, I’m Kevin Barr, Head of SEI’s Investment Management Unit. While our video crew typically operates from the studio at our headquarters in Oaks, they’ve leveraged the technology to let everyone film from home. 

With that in mind, I’ve asked Eugene Barbaneagra, Portfolio Manager of our managed-volatility strategies, to join me today from London. 

Thank you for joining me today, Eugene. I’d like to start out by asking you how the current market conditions are impacting our portfolios.

Eugene: Thank you, Kevin. From the market peak of February 19, our managed-volatility portfolios have slightly outperformed in both the international and global spaces, but lagged slightly in the U.S. In other words, our low-volatility equities did not provide the expected downside protection in the U.S.

Kevin: What happened here?

Eugene: I can see three reasons. 

We have experienced one of the fastest market drops ever. The speed of decline was three times faster than in prior peaks of 2000 and 2007. In panic de-risking, investors sold everything: cyclicals, defensives, stocks, bonds—although the bond investors were capped out by the Fed once again. For example, on the worst day (which I think was March 12), defensive utilities and the much riskier consumer-discretionary and industrial sectors performed similarly to each other. In fact, utilities actually fell more than the others. 

The second reason is market capitalization, or size, which was a huge driver. Unlike in the fixed-income markets that simply ceased to function in the liquidity crunch, equities continued to trade. But the smaller and less liquid the stock is, the lower the price that the forced sellers have to offer the buyers on the other side. Being active, our managed volatility portfolios are well-diversified, which leads them to bigger allocations to mid-caps and small-caps, and lower allocations to mega-cap stocks, and that proved to be detrimental to this liquidity-driven selloff in the last few months. 

And finally, there is no hiding from big tech. IT is a high-beta sector—it’s high-risk, it’s high-volatility—and naturally our managed volatility portfolios tend to run a significant underweight to that. But of course it did not drop as much as the rest of the market. The stay-at-home stocks naturally held up better. This was one of the reasons why low-volatility portfolios outside the U.S. performed relatively well: because their benchmarks don’t hold as many tech names that dominate the U.S. market.

Kevin: Eugene, where are you seeing opportunities arising from the crisis?

Eugene: Well, just like with the quarantine, I would say there are opportunities to do nothing, and opportunities to do something. 

So, in terms of doing nothing—after the initial phase of the panic selling, investors will begin to discriminate again, and the normal relationship between defensiveness and performance should return. So our managed-volatility portfolios are strategically designed to be defensive and therefore should provide a level of downside protection if the recession starts to materialize…and it becomes more and more evident that it will be the case. 

On the other hand, the headwinds or overweight to mid-caps tend to be self-correcting as well over time and it turns into a tailwind. 

But, there are also plenty of opportunities to do something as well. For example, both risk and return for our managed-volatility portfolios have an active, adaptive process. This market and consumer behavior will inevitably carry some permanent changes. Our managers’ risk models are likely to pick them up and incorporate them in the port construction process. On the return side, most liquidation offers valuation opportunities. For example, utilities haven’t been cheap for a while, and this is no longer the case. Likewise, many mid- and small-cap names offer good balance sheets, but they have been thrown out of the portfolios in sympathy with their neighbors. And they offer good opportunities for our managers. It is therefore not surprising that we currently favoring a great allocation to valuation-aware low-volatility managers within our portfolios.

Kevin: Given the implementation approach for managed volatility, what would you assume to be the portfolio’s behavior over the next 12-24 months?

Eugene: Our managed-volatility portfolios are strategically defensive. They are never positioned for a market rebound. So, answering this question requires a forecast of the market. The opposition to help to ride out the storm and we expect that our holdings will hold up better if recession is worsening. The earnings profile of our holdings is much stronger than the markets, which is a good property in challenging times like now. 

However, if there is a V-shaped recovery, then we would expect weaker companies—which otherwise would go bankrupt or would disappear—we would expect those companies to rebound. Naturally, the strategically-defensive managed-volatility portfolios are underweight those securities, and are unlikely to keep up with a strongly-rebounding market in the case of a V-shaped recovery.

Kevin: Do you think that this is a good time for active management?

Eugene: Absolutely. When the baby is thrown out with the bathwater, the ability to be selective is a key advantage. As irrational fears subside, good stock pickers should be able to show value.

Kevin: Thanks, Eugene.


Glossary of Terms:
Beta: Beta is a measure of the volatility, or systematic risk, of a security or a portfolio in comparison to the market as a whole.

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Information provided by SEI Investments Management Corporation, a wholly owned subsidiary of SEI Investments Company.

This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice and is for educational purposes only. Past performance is not a guarantee of future results. Positioning and holdings are subject to change. All information as of April 6, 2019.

Investing involves risk including possible loss of principal. Narrowly focused investments and smaller companies typically exhibit higher volatility. International investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles or from economic or political instability in other nations. Emerging markets involve heightened risks related to the same factors as well as increased volatility and lower trading volume. There can be no assurance that strategies discussed will or won’t be successful.

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