Is there a paradox that the managed volatility strategy
has outperformed the benchmark when the benchmark
performance has been so high over the period, and when the
beta of the strategy is supposed to be much lower than the beta of the benchmark?
1. Part of State Street’s Vision thought leadership series
SSgA CAPITAL INSIGHTS VIEWPOINTS
PHOTO
by
Frederic Jamet
Head of Investments SSgA France
The Q1 2013 Managed Volatility
Performance Paradox
What is the Paradox?
The Global Managed Volatility strategy aims to create a 100%
equity portfolio with minimum volatility within the MSCI World
universe. This strategy uses quadratic optimization in order to
produce the minimum ex ante volatility with the minimum set
of other constraints.
One major feature of the strategy is the low beta. This is a direct
consequence of the minimum volatility tilt. The typical
ex ante beta of the strategy is 0.6, which means that, according
to the CAPM theory, the excess return of the strategy should
be equal to 0.6 times the excess return of the market, i.e. the
MSCI World index. As such, the strategy is intended to offer
some downside protection in exchange for limited participation
in market rises.
However, from 31 December 2012 to 30 April 2013 the
performance of the Global Managed Volatility strategy has been
+16.31% versus +11.35% from MSCI World, outperforming the
benchmark by +4.96%.
Is there a paradox that the managed volatility strategy
has outperformed the benchmark when the benchmark
performance has been so high over the period, and when the
beta of the strategy is supposed to be much lower than the beta
of the benchmark? We investigated further.
Where does the Managed Volatility Paradox Come From?
It appears that the current characteristics of the managed
volatility strategy (as described in Figure 1) are in line with the
general description of the strategy, notably a low absolute risk,
a low predicted beta (less than 0.7) and a high tracking error
(more than 5%).
The absolute risk is much lower and this is the first objective
of the strategy. The beta is significantly lower at 0.65 and this
contributes to the high predicted tracking error of 6.0%.
The factor exposure supports this analysis.
Figure 1: Risk Characteristics of Global Managed Volatility
Strategy vs. MSCI World
Risk Characteristics
SSgA Global
Managed Volatility MSCI World
Predicted Tracking Error 6.00 --
Absolute Risk 9.57 13.82
Predicted Beta 0.65 1.00
R-squared 0.87 1.00
Percent Stock Specific Risk 5.63 #N/A
Percent Factor Risk 94.37 #N/A
Source: Factset. April 2013
2. 2
SSgA CAPITAL INSIGHTS | Q1 2013 MANAGED VOLATILITY
The largest factor difference by far is the volatility exposure.
Here the managed volatility strategy is underexposed at
-0.54 versus -0.11 for the benchmark.
To understand the current outperformance—outperformance
obtained while the strategy is in line with our expectations in
terms of risk profile—we ran a performance attribution analysis
by sector. In fact the main driver of the overperformance over
the quarter is mostly the difference in sector distribution
(detailed in Figure 3).
Logically, the managed volatility strategy is actively concentrated
in the less volatile sectors such as Consumer Staples and
Utilities and is actively underweighted in the most volatile
sectors such as Financials and Energy.
It appears that the sector dynamics during the quarter resulted
in a flight to quality and to underexposure to volatility at a time
when the most volatile sectors—such as Materials and Energy
and Technology—have significantly underperformed and
the less volatile sectors—such as Healthcare and Consumer
Staples—have overperformed.
Figure 4: Evolution of the Managed Volatility Strategy’s
Value Factor
— Value
Dec
2007
20092008 2010 2011 2012 Mar
2013
Factor Exposure Level
-0.6
-0.4
-0.2
0.0
0.2
0.4
0.6
0.8
Source: Factset. April 2013
Figure 2: Portfolio Risk Factor Exposure of Global Managed
Volatility Strategy vs. MSCI World
Data Data Difference
Exchange Rate Sensitivity 0.07 -0.04 0.11
Growth -0.18 -0.03 -0.15
Leverage 0.32 -0.01 0.33
Liquidity -0.12 0.20 -0.32
Medium-Term Momentum 0.03 0.02 0.01
Short-Term Momentum 0.14 0.04 0.10
Size -0.04 0.24 -0.28
Value -0.31 -0.03 -0.28
Volatility -0.54 -0.11 -0.42
Source: Factset. April 2013
Figure 3: Performance Attribution
SSgA Global Managed Volatility MSCI World Variation Attribution Analysis
GICS_SECTOR
Port.
Average
Weight
Port.
Total
Return
Port.
Contrib.
To
Return
Bench.
Average
Weight
Bench.
Total
Return
Bench.
Contrib.
To
Return
Average
Weight
Difference
Total
Return
Difference
Contrib.
To Return
Difference
Allocation
Effect
Selection
+
Interaction
Total
Effect
Consumer Discretionary 6.86 17.79 1.22 11.26 14.41 1.60 -4.39 3.37 -0.38 -0.11 0.22 0.12
Consumer Staples 24.39 17.73 4.32 10.82 16.44 1.73 13.57 1.28 2.59 0.69 0.31 1.00
Energy 0.01 6.13 0.00 10.09 5.89 0.63 -10.08 0.24 -0.63 0.54 0.02 0.56
Financials 8.77 12.32 1.09 20.58 13.64 2.77 -11.81 -1.32 -1.68 -0.24 -0.12 -0.36
Health Care 18.77 17.90 3.37 10.85 19.10 2.00 7.92 -1.20 1.38 0.61 -0.18 0.44
Industrials 1.71 3.00 0.06 10.95 9.72 1.07 -9.25 -6.72 -1.02 0.15 -0.12 0.04
Information Technology 1.69 11.51 0.20 11.63 6.60 0.78 -9.95 4.91 -0.58 0.49 0.10 0.60
Materials 0.34 15.22 0.05 6.38 -4.10 -0.27 -6.05 19.32 0.32 0.98 0.08 1.07
Telecommunication Services 11.58 15.97 1.86 3.77 15.46 0.57 7.81 0.50 1.29 0.34 0.08 0.41
Utilities 24.86 16.72 4.12 3.41 14.16 0.48 21.44 2.56 3.64 0.48 0.66 1.14
[Cash] 0.39 -0.44 -0.01 -- -- -- 0.39 -0.44 -0.01 -0.04 -- -0.04
[Unassigned] 0.63 0.95 0.02 0.24 -12.21 -0.02 0.38 13.16 0.04 0.01 -0.02 -0.01
Total 100.00 16.31 16.31 100.00 11.35 11.35 -- 4.96 4.96 3.92 1.04 4.96
Source: Factset. April 2013
Past performance is not a guarantee of future results.
Index returns are unmanaged and do not reflect the deduction of any fees or expenses. Index returns reflect all items of income, gain and loss and the reinvestment of dividends and other income.
Sectors shown are as of the date indicated and are subject to change.