BMO Global Asset Management has released a white paper that suggests active managers with a low-volatility strategy may be better able to manage risk, generate returns, and adapt to changing situations than passive investors.
In Low Volatility Equity Insights: A Case for Active Investing in Low Volatility Equity, BMO notes that passive low volatility investments often rely on a single measure to assess the riskiness of stocks, while active portfolio managers can calculate risk in several ways and using different techniques. BMO argues that doing so offers a wider view of risk that may result in lower realized volatility.
"We believe managers who use a more sophisticated approach to risk forecasting are typically better equipped to manage correlations during portfolio construction, and are better able to deliver a low risk portfolio rather than just a portfolio concentrated in low risk stocks," reads the paper.
While index providers follow rigid and predetermined portfolio construction techniques, the paper suggests that active managers have the flexibility to adapt their portfolios as conditions warrant; active managers can adjust for changing market risks (such as during the "taper tantrum" that took place in 2013), they can rebalance whenever they believe it is necessary rather than according to a predetermined schedule, and they can trade off risk and return, focusing on risk reduction during periods of higher volatility and generating higher returns when volatility is lower.
"Over the long term, smart adaptability should benefit both the upside and downside capture ratios of a low volatility portfolio," says BMO.