Volatility flare-ups have re-entered the investment landscape in early 2018. Is your portfolio as resilient as you would like it to be?

Institutions had been readying portfolios for the fallout of a market shift for some time now, according to the Natixis Investment Managers Global Survey of Institutional Investors.1 78% surveyed last fall said they expected stock market volatility to spike in 2018. Among their top allocation ideas was increasing the use of alternative investments. In fact, seven in ten institutions agreed that the addition of alternative investments is essential to diversify
portfolio risk.

Three volatility management specialists share their views on volatility levels, macro risks looming in global markets, and non-traditional routes to potentially minimize volatility in portfolios.


Our Panel Responses

Michael T. Buckius
Michael T. Buckius CFA®

CIO and Senior Vice President and Portfolio Manager Gateway Investment Advisers, LLC

2017 was a year of unprecedented low volatility for equity markets in the US and Europe, as well as Japan and emerging markets. But this global phenomenon couldn’t last forever.

Calm before the correction
For a portfolio manager who focuses on equity volatility, it was interesting to watch how low volatility could go, and how long it could last, prior to February’s stock market selloff. In fact, realized volatility for 2017 (as measured by the annualized standard deviation of daily returns for the S&P 500® Index) was just 6.78%, the lowest reading since 1964. Moreover, the largest peak-to-trough decline experienced by the S&P 500® Index for the year was a loss of just 2.58% from March 1 through April 13. Implied volatility, as measured by the
CBOE Volatility Index® (the VIX®), averaged 11.09 in 2017, the lowest annual average in the history of the statistic, which began in 1990.

The VIX® also set new all-time records for an intra-day low, 8.56 on November 24, and a closing low, 9.14 on November 3. The VIX® averaged 10.31 for the fourth quarter, the lowest quarterly average over its 112-quarter history. Moving back into a more historical average range of 20 in February 2018, the VIX® spiked to a closing high of 38.8 on February 8 and bounced down to 19.59 on March 2.

Catalysts to consider
One catalyst for volatility we are watching closely in 2018 is US inflation. If it becomes a headwind for earnings, that could cause a market downturn. Geopolitical tensions remain a significant risk to market stability, as well. Global trade issues, Brexit negotiations, North Korea’s nuclear ambitions, unrest in the Middle East, and China’s growing influence are among a lengthy list of events that could shake global markets in the coming months.

A low-volatility approach to US equities
For 40 years, Gateway has focused on managing portfolios that aim to make it easier to stay invested for the long run by reducing the impact of severe equity market downturns, while still participating in equity market advances. Unlike traditional long-only equity strategies focused almost exclusively on investment returns, Gateway’s index option approach seeks to find an optimal balance between risk and return. We think that consistency is the key to long-term investment success and that generating cash flow with index option selling, rather than seeking to predict price fluctuations in securities, can be a reliable, less volatile way to participate in equity markets.

We invest in a stock portfolio that seeks performance similar to the S&P 500® Index, then sell index call options to create cash flow. Writing covered call options may effectively trade potential (unknown) upside in the equity markets for (known) call premium. We may also buy index put options in an effort to help cushion the portfolio against a severe market decline. Again, following a consistent process, regardless of prevailing market conditions, is critical.

At the end of the day, we do think that the US equity market is the most reliable source of attractive long-term returns, despite its high volatility relative to other asset classes and tendency to periodically deliver significant losses over shorter periods of time.
Michael T. Buckius, CFA®

Michael Buckius is Chief Investment Officer and a Senior Vice President of Gateway Investment Advisers, LLC. He is also a Portfolio Manager. In addition to portfolio management, his responsibilities include overseeing the firm's investment management and trading functions as well as product development and servicing individual client relationships.

Prior to joining Gateway in 1999, Mr. Buckius was an equity derivative sales professional at Bear Stearns & Co. and Bankers Trust Company, both in New York. Previously he held a variety of option-related research and trading positions at Alex. Brown & Sons Inc. in Baltimore.

Mr. Buckius received his BA and MBA in finance from Loyola University of Maryland and is a CFA® charterholder.

Nicolas Just
Nicolas Just CFA®

Deputy CEO, CIO SeeyondSM*

Along with volatility, correlations (which is the degree to which prices of two securities move in relation to each other) dropped markedly in 2017 among equities. This makes sense in a growing market. However, if you look deeper, one would see that equity markets remained polarized between two groups of stocks: the cyclical and defensive. Our takeaway from this polarized equity market is that investors might not be as complacent and confident as one might think.

While global equity markets remained strong in 2017, there was also significant uncertainty about what might happen next. Geopolitical issues, central banks’ policy shifts, the Trump administration, and Brexit continue to keep many investors on edge. This uneasiness, we believe, helped fuel investor demand for minimum volatility and minimum variance equity strategies last year and into 2018. These types of strategies focus on investing in low-volatility stocks that have little correlation to each other. Their goal is to have lower volatility than the market capitalization-weighted indexes used by many investors. Overall, low-volatility equity investing strategies look to provide equity market exposure but with less volatility than the overall market by investing in low-volatility stocks.

Low volatility doesn’t mean minimal returns
According to traditional portfolio theory, seeking less risk by purchasing low-volatility stocks should reduce performance. But Seeyond’s research shows that low-volatility stocks have generated, over the long term, slightly more returns than higher volatility stocks, but with much less volatility. Why is that? We believe this anomaly is directly linked to the bias in the financial behavior of equity investors. They tend to overpay for the “glamour stocks,” overpaying for discovering the next big tech name or rising star, at the expense of the more “boring” stocks. And typically, over a full market cycle, we have found that these low-volatility stocks tend to outperform the overall equity market.2

With volatility capable of rising at any time, I think it’s important to remember that there may be ways to help make the equity component of portfolios more resilient.
Nicolas Just, CFA®

Nicolas Just joined Ostrum Asset Management in 2006. He began his career in 1994 as a derivatives trader in New York for Société Générale before becoming a strategic consultant for Cabinet Mars & Co. Nicolas then joined Exane as head of sell-side analysts for the distribution sector for European equities. Nicolas then joined the Japanese equity team of Ostrum Asset Management in June 2006 as an analyst and subsequently became equity portfolio manager. In 2008, he became head of the model driven equity management and after head of the core equity management team at the end of 2010. Since May 2012, he is head of the strategic equities team at Seeyond. Nicolas graduated from HEC Paris and from the CFA Institute and holds a master from the Community of European Management Schools.

Peter J. Martin
Peter J. Martin

Director of Client Portfolio Management AlphaSimplex Group, LLC

Volatility is something we spend a lot of time measuring and managing at AlphaSimplex. In fact, for all of our strategies, we are measuring and managing volatility on a daily basis. We have volatility targets, volatility caps, and volatility ranges for our portfolios. Each day, we can scale up a portfolio to a desired volatility target. We think this is important because we believe volatility can be a significant source of alpha (return excess of the market or benchmark).

Downside risk indexes hit zero in January
AlphaSimplex developed three proprietary indexes called the downside risk indexes – one each for US equities, international equities, and emerging markets. These indexes give us another way to analyze volatility. Essentially, we are kind of carving out the volatility that has been associated with price appreciation and price depreciation – good and bad volatility. We assign a value between zero and 100. For example, at 50, 50% of the returns are based upon downside risk and 50% upside risk. At 90, 90% would be downside risk and 10% upside risk.

In January, when global markets were continuing to move up and up, our downside risk indexes for both international equities and US equities were at zero. This is a measure I had never seen before, so we asked our research scientists to see if this had ever occurred. They found a period in the mid-1990s when it was at one, but never at zero. So I think this zero reading paints a nice picture of just how low volatility was up until the early February correction. It may also be an indication that things can only go one way from zero, as this index doesn’t go negative.

Institutional clients allocating into alternatives
Natixis’ Institutional Investor Survey results appear to be consistent with what AlphaSimplex Group has been hearing from many of our clients. Conversations we have been having with institutions since the second half of 2017 show they were expecting a rise in market volatility and were seeking alternative sources of return for their portfolios. In fact, managed futures strategies have been among the top requests that I have witnessed from clients.

In an environment of higher volatility and extended trends, upwards or downwards, trend-following strategies like managed futures may be able to provide returns that are uncorrelated with equities or fixed income. While we cannot forecast the future, we can say that markets are likely to change, both positively and negatively, and typically from  unanticipated sources. For those who are anxious about increased volatility, we believe that seeking some protection against that volatility is worthy of consideration.

Crisis alpha and managed futures
One of the most compelling attributes of managed futures strategies, I think, has been their behavior during US equity crisis periods, earning them the moniker that some have described as “crisis alpha.” In fact, examining the ten worst quarters on equity performance (as measured by the S&P 500 Index) between January 1990 to December 2017 reinforces the idea that managed futures (as measured by SG Trend Index) has the potential to provide positive results when equities are experiencing their more extreme negative outcomes. For the same periods, the quarterly return for managed futures averaged 5.9%, with only three negative quarters compared to the S&P 500 that averaged -13.3%. Also, during the worst quarter – the 2008 financial crisis (Q4), US stocks were down -21.9% compared to a positive 12.7% gain for managed futures.3

At AlphaSimplex, we believe a managed futures strategy has the potential to diversify an investor’s portfolio in three ways. First, you have the potential for performance in down markets. Second, low to non-correlation with other asset classes. And finally, you gain exposure to more types of assets that may help a portfolio even in non-crisis periods.

When we think of managed futures strategies as a group, it’s important to understand that not all managed futures strategies do the same thing. It depends on what approaches a particular strategy employs. Some focus in on very short-horizon trend signals, while others will only track very long-horizon trends. Still others follow short-, medium-, and longhorizon trends, trying to get a more diversified approach.

Understand the role of alternatives
Overall, it is critical to set expectations about alternatives and how they might perform in different environments. While some alternative strategies tend to lag market performance in strong bull markets, they may outperform markets in times of market distress. Investors need to have constructive conversations with their financial professionals to learn if alternative strategies are appropriate for them.
Peter J. Martin

Peter Martin is Director of Client Portfolio Management at AlphaSimplex Group, LLC, where he leads client service and client product engineering activities. Mr. Martin works in partnership with AlphaSimplex’s investment professionals, marketing, operations, and other business units to ensure that the full range of AlphaSimplex resources is brought to market in partnering with financial intermediaries and institutions. Mr. Martin also serves as Chief Marketing Officer of AlphaSimplex. He has over 25 years of professional experience in financial services.

Mr. Martin joined AlphaSimplex in 2010 from Natixis Investment Managers, L.P., where he was president of institutional services. Earlier at Natixis, Mr. Martin founded the firm’s wealth solutions unit and served as Executive Vice President and Head of Distribution for the Americas at Natixis Global Associates. Prior to joining Natixis in 2006, Mr. Martin spent six years as a managing director and national sales manager with Columbia Management Group. He also founded Katama Advisors, an independent investment consulting firm, and served as regional vice president at Fidelity Investments Institutional Brokerage Group.

Mr. Martin holds a BS in business administration from the University of New Hampshire and is FINRA series 3 licensed.


1 Natixis Investment Managers, Global Survey of Institutional Investors conducted by CoreData Research in September and October 2017. Survey included 500 institutional investors in 30 countries.

2 Based on the returns of stocks included in the MSCI All Country World Index from 12/31/1996 to 12/31/2006. Stocks were divided into 5 quintiles based on volatility measured by standard deviation. The lowest quintile, Q1, includes the stocks with the lowest volatility. Q5 includes the stocks with the highest volatility. Q1, on average, returned 9.40% with a standard deviation of 10.49%. Q2, on average, returned 8.15% with a standard deviation of 12.96%. Q3, on average, returned 7.90% with a standard deviation of 14.93%. Q4, on average, returned 6.25% with a standard deviation of 17.63%. Q5, on average, returned 5.74% with a standard deviation of 24.32%. Stocks are equal weighted and quintiles are rebalanced on a quarterly basis. Source: Bloomberg, Seeyond.

3 MPI Stylus, Morningstar, Natixis Investment Strategies Group. All data as of 12/31/2017. SG Trend Index is equal-weighted, reconstituted and rebalanced annually. The index calculates the net daily rate of return for a pool of Commodity Trading Advisors (CTAs) selected from the larger managers that are open to new investment. AlphaSimplex Group LLC is part of this Index. CTAs and such firms generally trade futures on commodities, currencies, financials or interest rates and may be highly leveraged. Strategies tend to be quantitative in nature and trend following, but may also focus on the fundamentals of the underlying or passively track an index.

Indices are unmanaged and do not incur fees. You may not invest directly in an index.

Performance data shown represents past performance and is no guarantee of, and not necessarily indicative of, future results.

Alpha is the measure of the difference between a portfolio's actual returns and its expected performance, given its level of systematic market risk. A positive alpha indicates outperformance and negative alpha indicates underperformance relative to the portfolio's level of systematic risk.
Call option is an agreement that allows an investor to purchase a security at a specific price within a predetermined time period.
CBOE Volatility Index® (VIX®) is a key measure of market expectations of near-term volatility conveyed by S&P 500® stock index option prices. The CBOE Volatility Index® (VIX®) reflects a market estimate of future volatility, based on the weighted average of the implied volatilities for a wide range of strikes, first and second month expirations are used until eight days from expiration, then the second and third are used.
Correlations refers to the degree to which the prices of two securities move in relation to each other.
Covered call is an options strategy whereby an investor holds a long position in an asset and writes (sells) call options on that same asset in an attempt to generate increased income from the asset.
Credit Suisse Managed Futures Hedge Fund Index is a subset of the Credit Suisse Hedge Fund Index that measures the aggregate performance of managed futures funds. Managed futures funds (often referred to as CTAs or Commodity Trading
Advisors) typically focus on investing in listed bond, equity, commodity futures and currency markets, globally.
Cyclical stock refers to an equity security whose price is affected by ups and downs in the overall economy.
Defensive stock is an equity security that has the capacity to provide a dividend and stable earnings regardless of the state of the overall stock market.
Downside Risk Index (DRI) is a proprietary index designed by AlphaSimplex to reflect the recent downside volatility of equity markets. Here, downside volatility is a measure of the extent to which recent volatility in an equity market’s daily returns has resulted from negative price moves (as opposed to volatility resulting from positive price moves). The DRI can range from 0 to 100, and higher values indicate that the recent level of downside volatility has been high relative to historically observed levels of  downside volatility. The DRI is not a prediction of future returns or volatilities of equity markets and investors should not rely on this
index when making investment decisions.
Index option is a put option or a call option whose underlying asset is an index.
Long position is the purchase of a security with the expectation that the asset will rise in value.
Managed futures are futures positions entered into by professional money managers, known as commodity trading advisors, on behalf of investors. Managers invest in energy, agriculture and currency markets (among others) using future contracts and determine their positions based on expected profit potential.
MSCI All Country World Index is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of developed and emerging markets.
Put option is an agreement that allows an owner of a security to sell an amount of said security at a specific price within a predetermined time period.
S&P 500® Index is a widely recognized measure of U.S. stock market performance. It is an unmanaged index of 500 common stocks chosen for market size, liquidity, and industry group representation, among other factors. It also measures the performance of the large cap segment of the US equities market.

Risks
Diversification does not guarantee a profit or protect against a loss.
Alternative investments involve unique risks that may be different from those associated with traditional investments, including illiquidity and the potential for amplified losses or gains. Investors should fully understand the risks associated with
any investment prior to investing.
Equity securities are volatile and can decline significantly in response to broad market and economic conditions.
Options may be used for hedging purposes, but also entail risks related to liquidity, market conditions and credit that may increase volatility. The value of the fund’s positions in options may fluctuate in response to changes in the value of the underlying asset. Selling call options may limit returns in a rising market.
Volatility management techniques may result in periods of loss and underperformance may limit the fund's ability to participate in rising markets and may increase transaction costs.
Managed futures use derivatives, primarily futures and forward contracts, which generally have implied leverage (a small amount of money used to make an investment of greater economic value). Because of this characteristic, managed futures strategies may magnify any gains or losses experienced by the markets they are exposed to. Managed futures are highly speculative and are not suitable for all investors.
Futures and forward contracts can involve a high degree of risk and may result in
potentially unlimited losses.

Commodity-related investments, including derivatives, may be affected by a number of factors including commodity prices, world events, import controls, and economic conditions and therefore may involve substantial risk of loss.

Before investing, consider the fund's investment objectives, risks, charges, and expenses. Visit im.natixis.com or call 800-225-5478 for a prospectus or a summary prospectus containing this and other information. Read it carefully.

CFA® and Chartered Financial Analyst® are registered trademarks owned by the CFA Institute.

The views and opinions expressed are as of March 1, 2018, and may change based on market and other conditions. This material is provided for informational purposes only and should not be construed as investment advice. There can be no assurance that developments will transpire as forecasted. Actual results may vary.

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