Market risks are on the rise and geopolitical tensions are escalating
The final months of 2018 represent a real opportunity for advisors - a period where they can prove their value by analyzing client portfolios and making adjustments where necessary. Market risks are on the rise and as geopolitical tensions escalate and the business cycle enters new territory, increasing exposures to low volatility investments appears to be a sensible option.
“Low volatility equities are designed to help investors protect value, and right now that is an important consideration,” says Chris Heakes, Director, Portfolio Manager, Exchange Traded Funds at BMO Global Asset Management. “We are moving into the later stage of the cycle and at this point it makes sense to think about how to play defence. It’s clear that low volatility ETFs will play an important role for investors going forward.”
BMO GAM currently offers six low volatility ETFs, all of which follow the same rules-based strategy. The funds differ in their geographical focus and offer exposures to low vol equities in the US, Canada, emerging markets, and EAFE. The suite aims to provide growth while protecting from market corrections by selecting lower beta securities that are less volatile than the broad market – investments that are generally defined as being defensive.
All ETFs in the suite are subject to security, sector and country caps to ensure a suitable level of diversification. The portfolios are rebalanced semi-annually, when security weights of the existing holdings are adjusted to reflect changes in their beta.
“All of the low volatility ETFs follow a disciplined investment strategy that provides strong downside protection,” Heakes says. “Low vol ETFs are a very good ‘buy-and-hold’ option. Over a longer period of time, like a full or multiple cycles, low volatility stocks often end up in a better position than other stocks because they do not go down as much during the volatile periods. They add value when clients need it most.”
Heakes is pleased with how BMO GAM’s low volatility ETFs are performing so far this year. The Low Volatility International Equity ETF (ZLI), which captures EAFE, has performed particularly well despite the volatility seen in some regions of Europe and Asia. The Low Volatility US Equity Hedged to CAD ETF (ZLH) and the Low Volatility US Equity ETF (ZLU, ZLU.U) have also performed well in 2018. The market has adjusted to higher interest rates in the US and valuations within low vol have returned to more reasonable levels. Over the past 6 months, the US low volatility ETFs have outperformed the index.
“The BMO Low Volatility Canadian Equity ETF (ZLB) is performing in line with the broad index year-to-date, but is certainly well positioned to outperform should anything negative happen, either through NAFTA or commodity prices,” Heakes says.
Given the current environment, Heakes encourages all advisors to seriously consider adding some low volatility exposure to client portfolios. In this era of constant geopolitical upheaval, it’s impossible to know from where or when the next market shock is coming.
“In an ideal world, we want all portfolios to be weather proofed against all types of weather,” Heakes says. “An important part of having a weather proof portfolio is having a portion of the equity exposure that can play strong defence when the market is falling.”
“It is good to have a mix, to be diversified between equities that will outperform should growth continue and equities that provide defence. When that weather turns a bit stormy, those solutions will be there to protect clients’ portfolios.”
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