Natixis: Don’t Oversimplify Volatility

[This ETF industry perspective is sponsored by Natixis Investment Managers.]

The Natixis Seeyond International Minimum Volatility ETF (MVIN) takes a unique but rigorous view on minimum volatility strategies. Natixis’ Seeyond affiliate manages MVIN, and the firm believes that passive approaches are simply too one-dimensional and static. Here, Alex Piré, head of Client Portfolio Management, Seeyond at Natixis Investment Managers, explains just what underlies Seeyond’s multifaceted view on a factor that is a moving target.

ETF.com: Would you give an overview on how Seeyond views the concept of volatility?

Piré: Seeyond understands that volatility is not just a number. It’s not just a very simple concept that can summarize market risk by looking solely at standard deviation, for example. We believe in a multipronged approach to truly evaluating the risk of a market or a market segment. In Seeyond strategies, the team tends to look at a combination of standard deviation, or volatility; correlations, or how securities interact with each other; and the externalities affecting those inputs.

As quantitative managers, a lot of what the team does is model-based, and so there’s this concept that if your data is not reliable, then your model is not going to be reliable. And so, we need to understand how the profile of the market is changing, given the investment, the current landscape and the economic landscape.

What we’ve seen for a couple years now is that volatility as a tool to understand market risk has been unreliable, mostly because of a very accommodative monetary policy across the globe that has really pushed down volatility in general. We can see that with the VIX. There’ve been some spikes in the VIX, but the bottom line is that, with everything that we’ve been through over the past several years, the volatility of the market has actually stayed relatively low.

Seeyond believes in a multidimensional approach to market risk. Look beyond just that volatility number. Include additional components. That’s why in MVIN, portfolio construction incorporates a number of different inputs, including a modified standard deviation that incorporates intra-period price movements – the volatility of individual stocks – but also, very importantly, the correlations, how these stocks interact with each other.

When you look at the resulting portfolio, it’s not exclusively made up of defensive stocks like you might expect from passively implemented minimum volatility or low volatility type strategies. Seeyond portfolios tend to move around. At times they can be much more cyclical. At times they might be much more defensive. At times they might have greater exposure to technology companies or healthcare companies.

The bottom line is that volatility as a concept is a moving target. How you construct a low volatility portfolio can change over time, and it’s therefore extremely important to have this multidimensional active portfolio construction approach. Because minimum volatility is a dynamic factor, active implementation is an equally important element that gives the team the leeway to change the portfolio as needed as the profile of low volatility evolves.

How important is the active management aspect of MVIN?

Piré: Active management is essential to deliver on the stated investment objectives of the fund. In MVIN, active management comes in two forms. The first is the ability to build a portfolio using an investment process or model that has a minimal amount of constraints embedded in the process. Through active management, we’re able to run our model on a weekly basis. We have a team of three portfolio managers that have eyes on that model, on that portfolio, and that actually implement those decisions on an as-needed basis.

Now, what that means is that we don’t have to overly constrain the process like an index would have to, because the model itself doesn’t have to live on its own. It allows for this human interaction to ensure that what’s happening in the model is consistent with our expectations of the investment strategy, and that we can have the best interest of the shareholders in mind whenever we’re making the final investment decision.

What we’ve seen through our research is that factor investing, in particular for dynamic factors like minimum volatility or momentum – those factors that tend to move around through time – in order to fully capture the premia of that factor, it’s essential to do two things. The first is to limit the amount of constraints in your process so that the model can express the spirit of the factor as much as possible.

Second, it’s essential – particularly in those dynamic factors – to have the ability to move the portfolio, to rebalance the portfolio, to change the portfolio as quickly as possible, in order to capture that premia as it moves around. That’s where the two facets of active management come into play with MVIN, and these two components actually contribute significantly to MVIN.

How does MVIN compare with passive approaches?

Piré: Put simply, we contend that passive implementation needs, as a primary objective, to limit implementation cost, while active management primarily seeks out the investment outcome; in MVIN, that means we primarily seek to minimize annualized portfolio volatility. These two approaches lead to significantly different implementation implications that can result in different outcomes for investors. Let me give you a few examples.

Let’s go back to data points. For instance, in MVIN, the process goes a lot further in the number of data inputs used in the investment construction model. In fact, the model includes tens of millions of data points on an annual basis, because Seeyond is looking at weekly model calculations across intra-period weekly and daily datasets. A passive approach will just look at monthly data, and typically only rebalances its index twice a year.

In addition, the ability of the portfolio to evolve through time with as-needed rebalancing means that, unlike with a passive approach, we can transition to a portfolio that’s drastically different when needed. This enables MVIN to be significantly more nimble and dynamic in the face of evolving markets. This can be particularly important in markets that quickly become more challenging, which is often when these strategies tend to be in greatest demand.

Finally, in terms of efficiency, throughout its track record, MVIN has yielded a beta of 0.6, a measure of its sensitivity to the market, and alpha generation, performance beyond beta-adjusted returns, of 5% annually. We tend to see passive approaches having a beta much closer to 0.8 and very little alpha generation. That’s a material difference and a significant source of efficiency in MVIN that can be very favorable to investors across market cycles.

Would you talk about MVIN’s role in a portfolio?

Piré: We look at MVIN and minimum volatility strategies in general as versatile strategies that can serve as core allocations with lower volatility or as outcome-based tools.

When I speak to advisors and investors, I see two main use cases for MVIN. The first one is a core allocation to international equity markets, with less sensitivity to the volatility of those markets. That means a smoother return profile for investors who are stuck between their need for equity return and those uncertain market environments that have the potential to lead to really significant market volatility and loss of capital.

Having a core allocation that can maintain that equity exposure to international markets without taking money off the table or putting it into alternatives, cash or commodities can be obviously very important. That can help investors who are more cautious, by reducing the overall risk of the portfolio and having a core that works harder for the investor with investment returns that are similar to the index, but with about 20%–30% less risk.

For investors who are looking to be more aggressive, who may have a longer-term horizon to distribution, what we see is that MVIN actually helps free up their risk budgets by having a core that works harder, that’s more efficient through exposure to risk. That risk budget they freed up can then be redeployed by the investor or by their advisors into strategies that might be less liquid or have higher expected risk profiles.

The other concept is the satellite approach, or what I like to call an outcome-based tool. MVIN has a dual investment objective of capital appreciation and volatility reduction. When you think about this objective, the outcome that MVIN is looking to yield is an asymmetric return profile that would capture as much of the upside as possible while mitigating volatility. MVIN can therefore be a ballast used to help diversify the portfolio and help reduce overall risk.

Ultimately, a product like MVIN can be used to fulfill several investment goals, whether it's outperforming the broader market over a full market cycle, whether it’s achieving significantly lower volatility and lower beta than the market, or simply complementing traditional active equity strategies that seek that alpha generation, but do it by taking more risk than the market.

RISKS

ETF General Risk:
Exchange-Traded Funds (ETFs) trade like stocks, are subject to investment risk, and will fluctuate in market value. Unlike mutual funds, ETF shares are not individually redeemable directly with the Fund, and are bought and sold on the secondary market at market price, which may be higher or lower than the ETF’s net asset value (NAV). Transactions in shares of ETFs will result in brokerage commissions, which will reduce returns.​​

Active ETF:
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.

Equity Securities Risk:
Equity securities are volatile and can decline significantly in response to broad market and economic conditions.

Foreign Securities Risk:
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 Risk:
Currency exchange rates between the US dollar and foreign currencies may cause the value of the fund’s investments to decline.

Alpha: A 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.

Beta: Measures the volatility of a security or a portfolio in comparison to the market as a whole.
 VIX: The 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.

Before investing, consider the fund's investment objectives, risks, charges, and expenses. You may obtain a prospectus or a summary prospectus containing this and other information. Read it carefully.

Seeyond is an affiliate of Natixis Investment Managers dedicated to Active Quantitative strategies.

Seeyond operates in the US through a participating affiliate arrangement with Natixis Advisors, L.P.

ALPS Distributors, Inc. is the distributor of 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.

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