Rising Volatility and the Long-Short Opportunity

QMA’s Stacie Mintz discusses reasons for higher volatility in 2019 and how a long-short strategy can help increase return potential while mitigating risks

February 08, 2019

QMA expects the divergence in global growth outcomes to narrow in 2019 as U.S. growth moderates closer to potential. Markets repriced significantly in 2018, and QMA expects that overall returns for 2019 will improve, while volatility will remain elevated. Coupling expectations for more muted earnings growth with uncertainty around tariffs and the potential for a Fed policy mistake, QMA is approaching the early part of 2019 with caution.

In the video clip below of an Asset TV interview, QMA Portfolio Manager Stacie Mintz, CFA, explains how a long-short strategy can help investors in this market environment by enhancing their return potential while controlling their exposure to risk.

View the full interview.

Valuations, volatility, and the case for long-short

There was a surprisingly wide value spread in 2018. The earnings yield spread between the most expensive and least expensive stocks in the Russell 3000® Index in 2018 was among the widest it’s been since 1987, challenged only by the financial crisis in 2008 and the tech bubble in the early 2000’s. So far in 2019, equities have been moving toward fundamentals, which has been good for value stocks. QMA expects valuations to be a key driver of equity returns in 2019, accompanied by more market volatility. This should bode well for long-short investors, providing ample opportunity to add value through stock selection. However, given that a payoff to value is notoriously tough to time, QMA remains exposed to quality, growth, and value stocks across their core strategies.

Two key reasons why long-short strategies are valuable in the current market environment are:

  1. Enhanced return potential . Value investing was challenged in 2018, and is expected to come back in 2019. In a long-short strategy, investors can buy stocks that are well-priced relative to fundamentals and short stocks that appear expensive. The portfolio benefits on both ends, normalizing valuation and adding alpha potential.

  2. Risk management. In a volatile market, many investors want equity-like returns but can't stomach the downside risk. Long-short strategies purchase long positions in attractive stocks along with short positions in unattractive stocks. This provides a net market exposure of approximately 50%. Investors can therefore reap the benefits of upside market potential with more limited downside risk.

Alpha measures risk-adjusted performance, factoring in the risk due to the specific manager rather than the overall market.

The views expressed herein are those of QMA at the time the comments were made and may not be reflective of their current opinions and are subject to change without notice. Neither the information contained herein nor any opinion expressed shall be construed to constitute investment advice or an offer to sell or a solicitation to buy any securities mentioned herein. This commentary does not purport to provide any legal, tax, or accounting advice. Certain information in this commentary has been obtained from sources believed to be reliable as of the date presented; however, we cannot guarantee the accuracy of such information, assure its completeness, or warrant such information will not be changed. The information contained herein is current as of the date of issuance (or such earlier date as referenced herein) and is subject to change without notice. Each manager has no obligation to update any or all such information; nor do we make any express or implied warranties or representations as to the completeness or accuracy.

Certain information contained herein may constitute “forward-looking statements” (including observations about markets and industry and regulatory trends as of the original date of this document). Due to various risks and uncertainties, actual events or results may differ materially from those reflected or contemplated in such forward-looking statements. As a result, you should not rely on such forward-looking statements in making any decisions. No representation or warranty is made as to future performance or such forward-looking statements.

 

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