A nervous market creates opportunities for active managers
A general sense of nervousness in the equity markets creates opportunities for active portfolio managers, says Shane Murphy, senior alternative portfolio manager at Irish Life Investment Managers.
Murphy said stock prices remain stable and the volatility of the S&P 500 is well below its long-term average. Yet many investors consider the stock market to be fragile.
“The market is pricing options as if the market is twice as volatile as it is,” he said. “This makes it a good environment to be really a net options seller and to try to earn that premium rather than just being a buyer of those options.”
He said a buzzword common in the industry in recent months was “fragility”.
“When you know that looking at the prices themselves, it doesn’t seem particularly volatile, but the market looks very fragile,” he said. “The market seems to be recovering from every drop, but every time there is a drop there’s a real nervousness out there that it could lead to something much worse.”
Given the reluctance, there is room to beat expectations. “There are a lot of opportunities for active managers and active strategies right now,” he said.
Murphy said growth-oriented tech stocks have delivered returns in 2020. Conversely, value stocks haven’t excited the market for some time, but are starting to look more attractive as rates rise. interest increases.
Value and growth “are constantly fighting each other right now,” he said. “What if you were in [a] strategy that has been heavily invested in one side of these – whether you were all growing or growing – that has the potential to be a much wilder race. “
Volatility, both perceived and real, can pave the way for profits, he said, and the best thing portfolio managers can do is identify volatile situations and then try to manage. fluctuations with derivatives.
“You cannot eliminate [volatility], and I don’t think you would want to do that because that would be like putting your whole wallet in cash, ”he said. “My philosophy on this is that you want to take risks that you think you are rewarded for. “
Murphy described two types of built-in risk premia: one in which you are rewarded simply for being long in the stock market, and the other in which you use derivatives and options to counter volatility risk. This second type can be intimidating, yet profitable.
“I think some people have a hard time understanding [options and derivatives]. They are generally associated with risk taking. But if you use them wisely, correctly, and responsibly, you can actually eliminate a lot of risk and help improve risk-adjusted returns for clients, ”he said.
Murphy prefers to use the “vanilla put and call options”.
“We’re not going to buy weird options with knock-ins or digital payouts or weird structures that might end up surprising us in a very big way. We want to do things in a fairly simple way, ”he said. “We don’t want to do anything unnecessarily complicated and we certainly don’t want to do something that we can’t sell fast enough if we need it in the market.”
He endorses a strategy of buying puts options with relatively long maturities and then selling shorter maturities at a profit.
Murphy is also a strong supporter of bonds, which he describes as the best risk mitigation products on the market.
“Good old fashioned government bonds or very high quality corporate bonds are probably the most reliable hedge you can get,” he said. “When stocks fall sharply, when there are really big sells in the stock market, capital flows into bonds.”
This article is part of the Soundbites program, sponsored by Canada Life. The article was written without the contribution of the sponsor.