How to invest as volatility increases in 2022: Portfolio Manager at OSAM

  • Volatility and losses marred the first quarter of 2022 after two years of mostly solid earnings.
  • But O’Shaughnessy Asset Management’s (OSAM) defensive stability strategy held up admirably.
  • Here are three sectors to watch for stability, according to Euan Mackay of OSAM.

The first quarter of 2022 is in the books. Unfortunately for investors, it was the US stock market’s first three-month stretch since early 2020.

Concerns about slowing economic growth, rising inflationto More aggressive Federal Reserveand the Russo-Ukrainian War have caused a drop in stocks and a rally in


volatility

.

But this tougher environment has helped O’Shaughnessy Asset Management’s (OSAM) “defensive stability” strategy outperform its benchmark Russell 1000 index from November 19 to March 31 by 4.7%, while reduces volatility by 5.4%. The defensive stability strategy fell 0.2% in that time, while the Russell 1000 fell 4.9% and the S&P 500 fell 3.5%.

EIGHT charts


O’Shaughnessy Asset Management


In the great debate between bulls and bears over whether a


recession

comes, OSAM is agnostic. the quantitative


Money Management

firm, which was acquired by Franklin Templeton in early 2022, instead, it uses a time-tested, data-driven approach to building portfolios, said Euan Mackay, OSAM’s client portfolio manager, in an interview with Insider.

The firm has several factor-based strategies that get the job done for institutional investors and financial advisors by “taking the thrill out of investing,” Mackay said. This means investors don’t need to have a strong opinion on what’s next for stocks or the economy.

“Instead of making a call about the short-term outlook for the market, what we’re really putting people on notice is: defensive stocks make sense,” Mackay told Insider. “You don’t have to be a bear for this strategy to make sense.”

Mackay continued: “If you have a long enough investment horizon, defensive stocks are a much more efficient way to gain market exposure than a simple passive index strategy.”

Defense wins championships

OSAM’s defensive stability strategy is based on the idea of ​​gaining “market exposure with significantly less risk,” Mackay said. Historically speaking, staying out of stocks entirely has proven to be a bigger mistake than going all-in at the peak of the market. But portfolio managers still need to prepare for downturns and volatility through effective risk management.

“Defensive stability is one of those strategies where we see that over long periods of time in the market, regardless of whether it’s up or down, the highest quality stocks, the most stable stocks, outperform significantly. pretty consistent over long periods of time. Mackay said. “And they do it very consistently with less risk.”

OSAM assesses whether stocks are of high quality and stable through three measures: a company’s operations, management, and trading volatility.

Mackay said operations are evaluated by the health and stability of a company’s earnings; management is judged by capital allocation decisions and whether they dilute shareholder value by issuing debt or equity; and volatility is judged both by action beta and the standard deviation of its past returns.

3 defensive sectors around which to build your portfolio

Mackay may not be authorized to reveal all the secrets behind the model that crafted OSAM’s defensive stability portfolio, but he did share three sectors that stand out in stability: consumer staples, health careand non-cyclical industrials. Conversely, the portfolio is underweight consumer discretionary and volatile information technology names.

Consumer staples stocks tend to outperform in times of market weakness because demand for essential goods like groceries and household items is not economically sensitive. This makes the group both defensive and less volatile, Mackay said, making it a natural choice in the portfolio.

Exchange-traded funds (ETFs) tied to the consumer staples sector include the Vanguard Consumer Staples ETF (VDC) and the Invesco Dynamic Food & Beverage ETF (pbj).

Similarly, many parts of the


Health sector

they are on the defensive because the demand for goods and services that save and improve lives is not exhausted in an economic downturn. However, Mackay pointed out that not all parts of the health sector fit this mold. He cited biotech stocks as an example of companies that don’t fit what he’s looking for, as losing, often highly speculative ones aren’t seen as defensive or stable.

Some ways to gain exposure to the health care sector include ETFs like the SPDR Healthcare Select Sector Fund (XLV) and the iShares US Medical Devices ETF (IHI).

Although generally considered cyclical, the industrials sector is full of stocks that are not economically sensitive, Mackay said. An excellent example of a defensive industry within the industry is aerospace and defense, the portfolio manager said, adding that those stocks are less volatile than their peers.

Major aerospace and defense ETFs include the SPDR S&P Aerospace & Defense ETF (XAR) and the Invesco Aerospace & Defense ETF (APP).

And while hindsight shows that any portfolio’s returns would have improved by adding exposure to the hot energy sector, Mackay said the once-defensive group would not have been a good fit for OSAM’s defensive stability portfolio.

The wild volatility in oil prices during the first quarter of the year translated into staggering gains of 37.7%; just another industry he finished that three-month stretch on the green. But wild swings in the sector disqualified energy stocks from the defensive stability portfolio in the first quarter. The unknown trajectory of the Russian-Ukrainian war means oil price volatility may not end soon.

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