Nilgosc turns to low vol equities

Low volatility stocks have seen increasing interest during recent years from pension funds seeking to avoid unfavourable price swings caused by short-term trading activity. The University Superannuation Scheme built a low volatility equity portfolio last year to limit exposure to market swings.

As soon as you start applying constraints to it you’re going to restrict the manager’s ability to perform how they would like to perform

Simon Cohen, Spence & Partners

Nilgosc, responsible for overseeing the country’s branch of the Local Government Pension Scheme, said its allocation to a minimum variance equities strategy reflects a need to close its deficit, last formally valued at £467m in 2013.

The £5.8bn fund said it expects the strategy to reduce downside risk while also paving the way for a move into alternative asset classes such as infrastructure.

“We’re quite an immature fund compared with some of our colleagues, so we still want to have quite a punchy weight in equities,” said David Murphy, chief executive and secretary of Nilgosc.

The low volatility mandate will act as a counterbalance to Nilgosc’s existing UK and global equity allocations, which have seen strong performance recently.

“It’s never going to shoot the lights out [...] but we’re hoping that when the market turns against us then the downside will be less,” said Murphy.

Avoiding the crowds 

Minimum variance strategies use mathematical formulae to compile a portfolio, which may contain certain stocks with a volatile share price but has a low overall level of volatility.

They can therefore deliver strong returns while taking relatively little risk, making low volatility equities “a bit of an anomaly”, said Ian Mills, partner in consultancy LCP’s investment practice.

“Low volatility equities, for unit of risk, give a better return, so it’s a better place to invest the equities, at least historically,” he said.

One explanation for the asymmetric risk-return profile of this asset sub-class might be a lack of interest from short-term institutional investors and the retail market.

Stable stock prices and steady income streams are unlikely to woo more aggressive investors, compared with more volatile equities, where sustained trading activity might in turn mean that schemes struggle to buy at realistic prices.

“It’s just the kind of thing that attracts interest, and as a result it tends to bid the price up a little bit more than its true fair value,” said Mills.

He recommended that schemes integrate low volatility allocations with other research-proven strategies in the equity market, such as investing in companies with high dividend yields, or companies where momentum can be seen in share price movements.

Elusive ESG

Nilgosc awarded its low volatility mandate partly based on the quality of manager Unigestion’s environmental, social and governance screening process. Murphy said he had been disappointed by the number of managers competing for the tender who paid only a passing consideration to governance issues, if at all.

“We still have managers saying that they do something when in fact, when you go behind it, there’s not a lot that stacks up there,” he said.

That low volatility managers are not primarily concerned with ESG should not be surprising, according to Simon Cohen, head of investment consultancy services at Spence & Partners.

“They’re constructing a portfolio that’s global equities, that’s low volatility, and that’s their focus,” he said. “As soon as you start applying constraints to it you’re going to restrict the manager’s ability to perform how they would like to perform.”

Cohen said while most managers would tailor a segregated mandate to consider ESG factors, demand from schemes remains low.

“There are very few schemes that are focused on ESG to be honest. Their primary concern is to get the best risk-adjusted returns from their assets and they’ll give a nod to ESG.”