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Will stock volatility flip when rates rise?

Low volatility stocks lose their defensive characteristics when rates go up and markets are under stress, fund managers told the audience at Expert Investor Norway last week. Is this a risk which could seriously unsettle markets, after the huge inflows into low volatility strategies in the past years?

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It definitely could, believes Erik Rubingh, who manages a global equity market-neutral strategy at BMO Global Asset Management. “A lot of investors have piled into minimum volatility products. While people typically buy these products to have less negative returns on the downside, they may be surprised in a negative sense if rates go up more than expected,” he said.

Both actively managed funds and passive strategies which target lower volatility have seen positive net inflows every month of the year so far, with total net investments in the asset class have been relatively totalling around €1.7bn.  

But are low volatility, dividend-paying, bond-like as you wish, stocks indeed more vulnerable to a rate rises than other equities? Jason Williams, a portfolio manager at Lazard Asset Management, had his ‘quants team’ look into the matter. The outcome of their endeavours was that low volatility stocks “tend to underperform when there is a sharp increase in interest rates,” said Williams. “But the likelihood of sharp rate increases is probably very low at this stage, given the amount of leverage in the system.”

Defense unraveled

Jan Keuppens, manager of the Robeco Global Stars Fund, didn’t see any reason to be sceptical about low volatility stocks, stressing that they have outperformed the index over the longer term. “If you look at 30 or 40 years of history of high quality, low vol companies in staples, food and telecoms, their downside beta is below their upside beta,” he said.

But is the Fed rate hike in December, which is now conceived as almost inevitable, actually a good thing? While most fund selectors and fund managers alike believe a rate hike is long overdue, Norway’s fund buyers are not so sure. Moreover, a small majority believe the Fed should postpone a rate hike to next year.  

Click here for a full overview of the voting results from Expert Investor Norway.

And click here to see a slideshow of photos taken at the event.

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