Performance data shown represents past performance and is no guarantee of, and not necessarily indicative of, future results. Risk is measured by standard deviation. Q1 (lowest quintile) represents low risk stocks based on volatility. Q5 (highest quintile) represents high risk stocks based on volatility. Based on returns of stocks included in the MSCI All Country World Index (Net). The 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. Stocks are equal weighted and quintiles are rebalanced on a quarterly basis.
Many financial professionals know of Harry Markowitz’s Modern Portfolio Theory (MPT), published in 1952. MPT has enjoyed a strong legacy as a very powerful asset allocation framework – but it is arguably a framework that is seldom well understood. What’s more, the theory may be anchored in a set of unrealistic assumptions about investor behavior.
One of the most contentious notions posed by MPT is that investors are rational actors. This implies that individuals are machine-like in their ability to consistently and accurately compute cost-benefit analysis across countless daily decisions – including investment decisions.
Research by Statman1 and Shefrin,2 and independent organizations like DALBAR,3 has demonstrated that investors are neither rational nor irrational, they are simply – to quote Statman – “normal.” Beginning in the 1980s, research in the field of behavior finance has helped to bridge the gap between MPT and our understanding modern investing behavior.
Behavioral finance tells us that investors are plagued by emotional biases, restricted by constraints, and prone to cognitive errors and operate with brains that absolutely love to take shortcuts. Of course, each of these tendencies can negatively affect their ability to make good investment decisions consistently over time.
Take, for example, the average holding period for mutual funds. According to DALBAR’s 2018 Quantitative Analysis of Investor Behavior (QAIB) Report,4 investors have held equity mutual funds for an average of less than 3.5 years over the past 20 years – yet most of these investors have investment horizons of 20–40 years!
Retention rates tend to shorten when the market is doing poorly, which can be seen as evidence of investors reacting strongly to near-term market losses and making the assumption that their most current investing idea could be better than their last.
On the upside, another investor fear tends to take over – the fear of missing out, or FOMO. FOMO can make investors jump around continuously seeking the best opportunity. This results in performance chasing, evidenced by the perpetual inflow and outflow cycles of funds if and when they transition drastically between Morningstar’s 5-star and 1-star ratings.5
Taking Stock of Today
Following the 2007–08 Global Financial Crisis, today’s markets are approaching one of the longest-dated recoveries in history. At Seeyond, we continue to see risk as asymmetrically skewed this late in the cycle. We are seeing a move away from synchronized global growth and evidence of a deceleration in global economies. Many investors are focused on this deceleration relative to the overall direction of the economy, which admittedly is still growing, but at a slower pace than in 2018.
There is certainly a scenario for equities to continue their upward trajectory, though at current levels, we would anticipate returns to be more muted. There may also be a strong case to be made for deceleration – and a slip into recession – which has the potential to deliver significant pain for investors. Thus, investors may be facing an asymmetric risk-reward relationship – smaller gains for further market growth than potential losses in the event of any major market downturn that might occur.
Managing Late-Cycle Risk
According to the 2018 Natixis Individual Investor Survey,6 nearly eight in ten financial professionals believe the long-running bull market has made investors complacent about risk. Given the current environment of asymmetric outcomes and potential for a near-term inflection point in the economic cycle, investors should consider the idea that the current market environment requires a more centralized focus on risk. This may be particularly true when it comes to international investing, as concerns about a global economic slowdown persist.
That’s where strategies such as the Natixis Seeyond International Minimum Volatility ETF (MVIN) have the potential to help investors. MVIN focuses on developed markets and seeks to generate long-term capital appreciation with less volatility than typically experienced by international equity markets. This minimum volatility approach seeks to diminish overall portfolio risk.
Although US equities rebounded from last year’s fourth-quarter tumult, May 2019 saw a new bout of volatility in markets stemming from the US-China trade war. Thus, it may still make sense for investors to consider strategies that seek to deliver on a dual mandate of realizing gains during market upswings and offering protection in a downturn.
Having this protection built in via an ETF wrapper can help investors avoid having to hedge their positions with the addition of uncorrelated assets like bonds or precious metals. The lockstep between stocks and bonds through May 2019 is not something typically seen within the capital markets, as both are prone to marching to the beat of their own drum. As such, investors can’t always look to bonds as the default go-to safe haven when the equities market goes awry. It’s important to note that the fixed income space was affected by the stock sell-off in the fourth quarter of 2018.
In a sideways market, investors may want to consider positioning their portfolios both to take advantage of potential further gains – and to protect against any volatility or significant downturn. Minimum volatility strategies can provide this kind of approach, seeking to ensure that investor portfolios remain well-positioned regardless of where their emotions may take them.
2 Shefrin, H. and Statman, M. (2000). Behavioral Portfolio Theory. The Journal of Financial and Quantitative Analysis, 35(2), p. 127.
3 DALBAR, Inc. is an independent company for evaluating, auditing and rating business practices, customer performance, product quality and service. Launched in 1976, DALBAR has earned the recognition for consistent and unbiased evaluations of investment companies, registered investment advisers, insurance companies, broker/dealers, retirement plan providers and financial professionals.
4 “Quantitative Analysis of Investor Behavior (QAIB) Report.” DALBAR Inc. 2018. Data for period ending December 31, 2017.
5 For each fund with at least a three-year history, Morningstar calculates a Morningstar Rating™ used to rank the fund against other funds in the same category. It is calculated based on a Morningstar Risk-Adjusted Return measure that accounts for variation in a fund's monthly excess performance, without any adjustments for loads (front-end, deferred, or redemption fees), placing more emphasis on downward variations and rewarding consistent performance. Exchange-traded funds and open-ended mutual funds are considered a single population for comparative purposes. The top 10% of funds in each category receive 5 stars, the next 22.5% receive 4 stars, the next 35% receive 3 stars, the next 22.5% receive 2 stars and the bottom 10% receive 1 star (each share class is counted as a fraction of one fund within this scale and rated separately, which may cause slight variations in the distribution percentages). Past performance is no guarantee of future results.
6 Natixis Investment Managers, Global Survey of Financial Professionals conducted by CoreData Research in March 2018. Survey included 2,775 financial professionals in 16 countries.
Exchange-traded funds (ETFs) trade like stocks, are subject to investment risk, and will fluctuate in market value. Unlike mutual funds, ETF shares are bought and sold at market price, which may be higher or lower than the ETF’s net asset value. Transactions in shares of ETFs will result in brokerage commissions, which will reduce returns. Unlike typical exchange-traded funds, there are no indexes that the Fund attempts to track or replicate. Thus, the ability of the Fund to achieve its objectives will depend on the effectiveness of the portfolio manager. There is no assurance that the investment process will consistently lead to successful investing. 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. Equity securities are volatile and can decline significantly in response to broad market and economic conditions. Foreign securities may involve heightened risk due to currency fluctuations. Additionally, they may be subject to greater political, economic, environmental, credit, and information risks. Foreign securities may be subject to higher volatility than US securities, due to varying degrees of regulation and limited liquidity. Currency exchange rates between the US dollar and foreign currencies may cause the value of the fund’s investments to decline.
Sustainable investing focuses on investments in companies that relate to certain sustainable development themes and adherence to environmental, social and governance (ESG) practices, therefore the Fund’s universe of investments may be reduced. It may sell a security when it could be disadvantageous to do so or forgo opportunities in certain companies, industries, sectors or countries. This could have a negative impact on performance depending on whether such investments are in or out of favor.
All investing involves risk, including the risk of loss.
Diversification does not eliminate the risk of experiencing investment losses.
This material is provided for informational purposes only and should not be construed as investment advice. The views and opinions expressed above may change based on market and other conditions. There can be no assurance that developments will transpire as forecasted.
Before investing, consider the fund's investment objectives, risk, charges, and expenses. Visit im.natixis.com for a prospectus or a summary prospectus containing this and other information. Read it carefully.
ALPS Distributors, Inc. is the distributor for the Natixis Seeyond International Minimum Volatility ETF. Natixis Distribution, L.P. is a marketing agent. ALPS Distributors, Inc. is not affiliated with Natixis Distribution, L.P.
Seeyond is a subsidiary of Ostrum Asset Management. Operated in the US through Ostrum Asset Management U.S., LLC. Ostrum Asset Management U.S., LLC. and Natixis Distribution, L.P. are indirect subsidiaries of Natixis Investment Managers.