Risk managers tend to reduce their market exposure (or
increase hedging) in response to signs of escalating risk,
extrapolating from current volatility and correlation trends.
Investors, tending to bet on mean reversion, typically focus on
returns, frequently adding to their highest-conviction
positions in the face of rising uncertainty.
The investor approach was long an engine of success. From
1993 through 2007, buying the market on dips paid off. While
the S&P 500 fell at an annualized rate of more than 20
percent during months when the CBOEs volatility index
(VIX) rose more than 1 percent, it bounced back smartly in the
Since 2008, however, the risk-management approach has
triumphed. In months when market volatility has risen by 1
percent or more, the market fell at an annualized rate of
nearly 70 percent on average and continued to lose
ground in the following month as well, as the display below
We strongly suspect that the poor performance of active
managers over the last several years has been at least partly
tied to the inherent conflict between relying on
shorter-horizon risk management while seeking returns from
investments that can take years to play out.
Last year, for example, investors who took a flier on
long-horizon stocks in mid-year were burned at first. The
S&P 500 lost 14 percent in August and September. But those
who exited during the market drop missed the rally that began
in October and has intensified more recently. The problem was a
risk/return mismatch: seeking short-term gratification from a
Hence, in the current market we believe that paying
attention to systemic sources of risk and return will be at
least as important as the selection of specific securities.
In 2011, the systemic exposures that really mattered were
dividend yield and low-volatility/low-beta. Stocks with these
characteristics outperformed. But as a result, such stocks have
become extremely crowded and expensive making some
traditionally low-risk strategies very risky.
Today I see three themes that offer a powerful upside:
dividend growth (rather than yield); compellingly valued beta
or cyclicality, and companies attractive on the basis of
normalized cash (candidates for leveraged buyouts).
How much to invest in each of these themes depends on each
investors investment horizon. Longer-horizon investors
would generally emphasize undervalued cyclical stocks and LBO
candidates, which I expect will return to favor over time.
Short-horizon investors should emphasize dividend growth.
Rebalancing will also be crucial. I favor adding to risk
exposures as volatility rises and reducing risk as the markets
become calmer. Today, with the markets charging ahead, I think
a modestly defensive tilt is in order.
While there are clear signs of economic improvement and some
of the sovereign-debt problems have been ameliorated, the basic
risk-management philosophy has not been altered by these recent
events. Hence, increases in perceived risk will be accompanied
by outsized market drawdowns and investors will be well served
by maintaining a highly diversified stance and rebalancing
position sizes in line with market volatility.
The views expressed herein do not constitute research,
investment advice or trade recommendations and do not
necessarily represent the views of all AllianceBernstein
portfolio management teams.
Vadim Zlotnikov is Chief Market Strategist at