I have written previously in this column about a number of trends in product development and issuance by fund managers including unconstrained bond funds and real return targeting funds.
Another that falls into the product trends category is the emergence in recent times of low volatility and low beta equity funds, both Australian and international equity funds. The emergence of these funds is yet another product theme aimed squarely at the retiree market.
While there is a distinction between low volatility and low beta equity funds, the broad concept is reasonably similar. That is, as a generalisation, the funds are designed to provide returns that are competitive with the underlying equity market benchmark in which they invest in, but produce this return with a materially lower level of volatility.
It is these characteristics that make these funds attractive to retiree investors, namely for two reasons:
- Retirees cannot afford to lose capital and given that they are generally drawing down on their capital in retirement, do not have the same ability to benefit from dollar cost averaging in market dips given they are not regularly investing back into their portfolio.
- Retirees are often willing to give up some of the upside growth potential for greater protection of their capital on the downside. In addition, the ability to recover from negative market conditions is greater where the negative return is less. (i.e. a 20 per cent decline in capital requires a 25 per cent return to recover the losses incurred while a 30 per cent decline requires a 42.9 per cent return to recover the lost capital).
Like most product categories there is a variety of differing investment approaches and fund types in the low volatility, low beta ‘space’. Some managers seek to invest in a portfolio of stocks that individually demonstrate lower volatility than the market. In Australia, some of the financial services stocks such as banks with their high dividend paying characteristics are often considered lower volatility stocks. Other managers seek to construct an overall low volatility portfolio by combining stocks that demonstrate low correlation with each other resulting in a highly diversified portfolio with lower volatility than the broader market.
In the low beta category, we have seen the popularity of equity income funds where a number use a buy-write option strategy where the manager sells call options over portfolio holdings to generate additional income from the fund. This strategy often results in a portfolio demonstrating lower beta than the market, meaning the fund is less sensitive to market moves, both up and down and so will not participate in the full upside in bull market conditions, but conversely will not fall by as much in bear market conditions. The additional income generated from many of the equity income funds has also been a major attraction for retirees.
So in summary, low volatility, low beta equity products can serve a valuable purpose in portfolios, particularly those in retirement where protection of capital and stability of returns is vital.
David Wright is the director of Zenith Investment Partners
