This is only my second blog post and already I’m pushing breakfast back to 2:30 in the afternoon —so decadent!On a more serious note, that was the most convenient time for me to chat with Gibson Smith, co-CIO and portfolio manager at Janus Capital. He was in town, accompanied by Colleen Denzler, head of fixed income strategy, to discuss a new white paper they’ve published on why it is an important time to use active bond management rather than passive—or even a bond ladder. That is, after Gibson finished marking the articles from Financial Planning’s September issue to read on the plane back to Denver.
But I wanted to talk about something else: why so few people had a well-thought-out bond strategy, whereas everyone seems to have a highly researched point of view about equities. Most people I hear talk about bonds seem to share one message: buy them. That’s asking for trouble, especially when we’re in a low-yield environment. (Notice I did not say “bubble.” More on that later.)
“Fixed-income strategy is one of the areas that’s been overlooked for one or two decades,” Gibson answered. The reason is simple: That’s the lifespan of an incredible bull market in bonds occasioned by disinflation, globalization and the downward drift of interest rates since their highs in the early 80s. Since then, bonds have been both a safe bet relative to equities, and a good investment. What’s more, Gibson points out, over the past 11 years, Treasuries have outperformed equities. That made it pretty easy for any old bond, bond fund, bond index or bond ETF to seem like a smart choice. No surprise, then, that money has poured into the sector.
“The events of 2008 led many investors into quasi-rebalancing and a pseudo capital preservation mindset,” Gibson says. (Obviously, he isn’t shy about his opinions.) “People migrate to fixed income and there’s an illusion of preservation of capital. That is true in some cases but there is still risk.
“Strategy is important; now that yields are down, people are looking at longer durations and that equals greater risk. So it’s really important for advisors to step back and think about their mix of fixed income and other investments—how and where you generate yield as well as the total return of the portfolio,” he says.
Clearly, interest rates can’t go much lower than they are now, and if you trade bonds, a rise in rates will bring a loss of principal. Nevertheless, individuals continue to yank money out of stocks and reallocate to bonds. And yet, Gibson dismisses the idea that we’re in a bond bubble: “People have been talking about a bubble for 18 months but yields continue to grind lower,” he says. “The 30-year bond is up 20% year-to-date and fixed income has outperformed equity by almost 10%. That’s forcing investors to step back and reconsider their allocations.”
At this point in our visit I got indelicate and reminisced about Janus’ participation in the tech bubble back in the glorious 90s, when Jim Craig was a genius and stocks, not bonds, were the answer. Gibson stuck to his guns. “If you look at absolute yield, we don’t have many reference points with a disinflationary or deflationary environment,” he says. “Today’s real return is close to long-term averages.”
Breakfast With Champions: An Interview with Harindra de Silva (Aug. 27)
Welcome to my new blog, which will talk about the interesting financial services industry folks I meet in my role as editor in chief of Financial Planning. We frequently meet for breakfast, hence this title. I hope you’ll find interesting ideas, and perhaps have the occasion to meet up with me for early morning coffee and conversation.
This week, I had the pleasure of breakfasting with Harindra de Silva, president and portfolio manager at Analytic Investors, an investment firm that manages institutional portfolios and mutual funds using a quantitative approach and has about $7.2 billion under management. The firm is owned by Old Mutual. Many quant firms have suffered since the market meltdown in 2008, particularly long/short funds, and the long/short fund Harin co-managed, Old Mutual Analytic U.S. Long/Short, was no exception. But he has another portfolio that is doing quite well, and that’s what we discussed this week.
“The biggest change I’ve seen among clients has been that they’ve stopped wanting to beat the market,” Harin says. “The market is not going somewhere. Now risk matters more.” So he and his team have been paying more attention to reducing risk in a domestic and a global portfolio using what they call a Volatile Minus Stable (VMS) strategy. Simply put, they’re buying the stocks in the S & P (domestically) and MSCI World (globally) that are in the bottom quintile for volatility—that is, their prices have the lowest standard deviations. The strategy reduces the risk in a U.S. portfolio by 25% and in a global portfolio by 35%.
The VMS strategy is based on academic work done in the mid-nineties. Studies revealed that, over time, volatility provided no reward premium over stocks whose prices had less variance, owing to compounding effects. So about seven years ago, Harin decided to build an equity portfolio with no complexity, no shorting, just low risk. “My partners thought, ‘here’s one more oddball idea,’” he says. “Then a pension plan called up and requested a pitch book.”
Research Harin did with his colleagues Roger G. Clarke, Analytic’s chairman, and Steven Thorley, Analytic’s research advisor, showed that over time, volatility gave you no premium on performance. “Most investors expect that a portfolio with more volatility will have a higher return. Our research challenges this belief, showing that over long periods, there has been no extra reward for choosing volatile stocks over stable stocks,” they wrote in a paper published in the Winter 2010 issue of The Journal of Portfolio Management.
Today, the low-volatility idea has begun to spread. MSCI has come with the MSCI Minimum Variance index, which mimics it; someone (not Harin) has licensed it for an ETF. A mutual fund version of Harin’s portfolio is available on the SEI platform, SEI Instl Mgd US Managed Volatility A [SVOAX]. For investors looking for a smoother ride, this might be a sound approach.
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