In the current low interest rate environment, investors are constantly on the lookout for yield. The Eastspring Investments - Asian Low Volatility Equity Fund ("ALVE Fund") offers a distribution payout feature by focusing on dividend paying stocks that are less volatile. Given that dividend income is a substantial driver of total returns over the long term, investors can utilise this consistent stream of income to accumulate wealth over time.
* Distributions are not guaranteed. Distributions may be paid out of capital.
Source: CLSA Research, 31 January 2016. MSCI Asia Pacific ex Japan
Distributions are not guaranteed and may fluctuate. Past distributions are not necessarily indicative of future trends, which may be lower. Distribution payouts and its frequency are determined by the Board of Directors, and can be made out of (a) income; or (b) net capital gains; or (c) capital of the Fund or a combination of any of (a) and/or (b) and/or (c). The payment of distributions should not be confused with the Fund’s performance, rate of return or yield. Any payment of distributions by the Fund may result in an immediate decrease in the net asset value per share.
While there are existing products that are branded as solutions for managing volatility in an Asian equity portfolio, the ALVE Fund does so with a unique investment process and is among the few that are systematic and are grounded in factor-based investing.
Factors are observable and quantifiable security-level characteristics such as Value, Quality, High Dividend Yield and Low Volatility that can explain systematic return patterns in the equity markets (and other asset classes). Factor-based investing requires a high degree of expertise and sophisticated data infrastructure to capture, analyse and take action on market information.
The ALVE Fund is managed by dedicated experienced and capable quantitative specialists that have an average of 17 years of industry experience. This team is responsible for a similar strategy that has been successfully managed on behalf of an institutional client for nearly 3 years.
To create the portfolio, the team starts with a very broad Asia Pacific (ex Japan) universe, the S&P BMI Pan Asia ex Japan Index which comprises over 3,500 companies. This is then filtered for investability using minimum market cap thresholds. This reduces the number of stocks to around 1,000. This gives us a far richer data set than the capitalisation weighted MSCI Asia Pacific (ex Japan) Index which only contained 705 companies (as at 30 June 2016). Our filtered universe of around 1,000 stocks allows us to draw on far greater number of potential low volatility candidates for our portfolio.
We further exclude stocks that do not pay dividends, or that have below market average dividend yield. We are aware that low volatility strategies tend to appear more expensive than the broader parent index on measures like Price to Book and Price to Earnings basis. In an effort to reduce this valuation gap, the process excludes stocks with poor valuation and sentiment. Utilising value and sentiment filters may reduce the risk of buying into expensive stocks that are more likely to underperform due to increasing poor analyst sentiment.
We also filter for other factors including quality, which filters on the basis of metrics such as profitability and debt-to-equity.
These filters further reduce the number of stocks in the universe to around 300.
Portfolio construction and stock selection is largely quantitative, aiming at constructing a minimum volatility portfolio from an investable dividend yield focused universe. An optimization process is applied to derive the optimal weights. A number of constraints – such as maximum individual stock weight, portfolio concentration, liquidity, sector, country and style exposures – are applied in order to manage systematic and idiosyncratic risk. These weights are selected not to maximize return, but to minimize portfolio volatility, a procedure which is less susceptible to forecasting errors and behavioural issues. By seeking to minimise portfolio volatility the Fund achieves two important outcomes: exposure to the low volatility style and greater diversification as stock correlations are considered.
As an outcome, the ALVE Fund has a portfolio of stocks which is differentiated from most active managers as well as the MSCI Asia Pacific ex Japan index. With around 100 stocks, the ALVE Fund has nearly 60%1 more stocks than the typical fund investing in Asia Pacific ex Japan equities, enhancing diversification and reducing stock specific risk.
1Based on the median number of stocks holdings for funds categorised to be invested in Asia Pacific ex Japan equities by Morningstar.
Historically low volatility strategies have had higher returns than the broad market indices with lower volatility as is evidenced in the following chart.
Source: Eastspring Investments, in USD as at 31 August 2016. Please note that there are limitations to the use of such indices (index) as proxies (a proxy) for the past performance in the respective asset classes/sector. The historical performance or forecast presented is not indicative of and should not be construed as being indicative of or otherwise used as a proxy for the future or likely performance.
A low volatility equity portfolio offers investors a peace of mind. With volatility of returns lower at the portfolio level, the value of investment is less likely to decline as much as the broad market during times of market distress. The Fund thus aims to deliver better risk-adjusted returns with an attractive dividend yield across market cycles through a lower drawdown during market downturns.
Comparing monthly returns since December 20012, we observe that the median value of the ratio of declines between the MSCI Asia Pacific ex Japan Minimum Volatility index and the MSCI Asia Pacific ex Japan index was 0.73. This indicates that the Minimum Volatility variant of the index frequently fell approximately 27% less than the broad market index over the last 15 years. As a result of this lower drawdown, a low volatility approach to investing in equities allows the portfolio to accumulate wealth consistently across market downturns.
2As at 30 September 2016
Source: Eastspring Investments, Bloomberg, MSCI Indices, data as of 31 December 2001 to 31 August 2016.