Q&A with Harin de Silva, Analytic Investors
Sub-Advisor of 361 Global Long/Short Equity Fund
Harin de Silva, President of Analytic Investors, has seen his share of market selloffs over the years. Yet, with the end of the latest bull market likely nearing, he’s not worried about increased volatility—and investors don’t have to be either, he says.
We’re in a challenging market environment now, don’t you agree?
If you’re referring to its volatility, yes; for some, I suppose. I was with some friends of mine who work for a fundamental firm. They were very concerned about the surge in market volatility. They tend to get a lot more excited about such things than we do. We just say “It’s not normal, but it isn’t unusual.”
Certainly, volatility is higher than we’ve seen historically, but every five years or so, you should expect an environment like this. You shouldn’t be surprised by it.
Unfortunately, volatility goes away pretty slowly. When the VIX is at 40 and its long-run average is 20, it takes three to four months to get back down to its historical average. Very seldom does volatility go away in a nanosecond.
What do you anticipate for the market in the coming year (i.e., 2016)?
Forecasting the market is not something that I try to do. Neither is building portfolios based on the recent past.
Look at the market in the last year. Volatility was incredibly low. Now it’s spiked much higher. You shouldn’t build a portfolio based on last year’s story. What you should do is peer over a longer horizon; you’ll see that you’re bound to get volatility shocks from time to time.
So, if I had to speculate, if I had to look forward for the next year, you really should be building a portfolio with the expectation that you’ll see more selloff days like those in late August.
Are there certain sectors that exhibit greater volatility than others?
That changes over time, obviously. Five years ago, banking was the most volatile sector. No longer. Right now, the most volatile sectors are energy and commodities.
And the least volatile?
The least is utilities. Utilities have consistently been low volatility issues but they’ve suffered macro shocks, too. Remember the Enron-era crisis when a number of utilities flirted with bankruptcy? Their stocks were very volatile then. The other issue with utilities is their interest rate exposure. In a rising rate environment, you might want to look at the consumer staples sector which also exhibits relatively low volatility.
What about exogenous events such as increasing globalization and market efficiency. Have you had to adapt to that in some way?
Investors think about stocks as belonging to a certain country, a certain region or a certain industry. They use fundamental risk models to build their portfolio. I think those models are susceptible to changes in the global structure. Take a company like Nestlé, which is based in Switzerland; it’s not really a Swiss company because so much of its revenues actually come from emerging markets. So how will Nestlé behave? Like a developed country stock or an emerging market issue? I think the way you can get around this dilemma is to build models that are purely return-based. Take all the stock returns and put them into groups based on their correlations. Correlations and geography are related, but only to a degree. Developed market stocks generally tend to be highly correlated. Second-tier correlations are found mainly in emerging markets, especially China. A third cluster of lower-correlation issues, like those from Brazil, tend to operate more or less on their own. We’ve come to recognize the weakness in using country-of-domicile as a proxy for where a company operates.
What about differing levels of market efficiency? Obviously, liquidity is a factor in some markets more than others.
If we were running an equity portfolio which included emerging and frontier market securities that would be an issue. In the global long/short portfolio, we’ve been very careful to select stocks that generally have very similar accounting and disclosure standards. With regard to efficiency, I’m not so sure. Efficiency differs widely across these markets.
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