InvestmentFront
A Smoother Ride:
Low-Volatility
Equity Strategies

By John P. Calamos Sr.

Many investors are afraid to be in the markets today, due to a sluggish economic recovery in the U.S., worries over European government defaults and a volatile stock market. Other investors, however, are afraid to be out of the market, not wanting to miss the beginning of a possible bull run in stock prices.

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However, the current volatility and uncertainty are not reasons to stay out of the markets. If that were the case, there would never be a good time to invest! What matters is finding the opportunities amid the volatility and developing an asset allocation that addresses the reality of today’s markets. Not all securities will fare equally well, quality will matter, and money managers who are active with highly selective strategies will continue to find ways to add value.

Therefore, what investors need are asset allocation strategies that address the current reality. For many investors, the blend of assets in their portfolio should include a core component with lower risk than a traditional stock-only allocation. These financial tools are known as low-volatility equity strategies, but they are not clearly understood by many investors.

What are Low-Volatility Equity Strategies?

The objective of low-volatility equity strategies is to outperform the broader equity market by reducing an investor’s downside risk. These strategies – which are also referred to as defensive equity strategies - seek to participate in a greater portion of equity upside than downside over a full market cycle by using convertible securities. The securities incorporate a company’s convertible bond to provide downside protection when the stock market drops (due to the bond’s value and coupon income) but allow for the conversion into the company’s stock to capture upside appreciation when the market rises. Investors do give up a portion of their upside equity returns with convertible securities, but the overall balance of risk/reward makes low-volatility equity strategies an appropriate core asset that many investors may want to consider.

These low-volatility strategies have proven to be effective in uncertain markets for decades. I personally witnessed their success during the sideways markets of the 1970s, the challenging environment of the early 1980s and other recent periods - including the turbulent “mini-cycle” of 2008-2009 - where these strategies outperformed their benchmarks and their peers.

This is not simply an asset allocation model with two different types of securities like a “balanced strategy” that blends some stocks and some bonds in a portfolio. Rather, this is a risk-managed approach including convertible securities designed to maintain an acceptable risk posture throughout the market cycle, and can offer investors time in the market with a comfort level that neither stocks nor bonds alone can provide.

Risk Management with Low-Volatility Equity Strategies

As difficult as it may be, the reality is that volatility is always a part of investing. An active investment manager should analyze existing and potential risks in the market and develop proactive strategies that address and even capitalize on them. Analysis should focus on the risks associated with an individual security itself, the industry of the issuing company and the economic sector in which that company operates. In addition, research should include a focus on the complex inter-relationship between events, sectors and economies, particularly as they relate to changes in wages, salaries, savings, imports and exports, and consumer trends around the world.

The flipside of volatility is opportunity, and controlling risk is a key factor in wealth creation. The primary goal of risk management is to contain equity risk without giving away equity opportunity. The bottom line is that properly researched, actively managed low-volatility equity strategies mitigate the need to make choices about when to get in and out of stocks - which are difficult decisions to determine in whipsaw markets.

As we look to the remainder of 2010 and beyond, we believe equity market volatility will continue. At the same time, the equity markets continue to be the best place for long-term investors - especially since stock valuations are very compelling. In my opinion, growth companies are the cheapest we have seen in twenty years. Some investors might view the current volatility as an uncomfortable, unwinnable contradiction, but we do not. Low-volatility equity strategies provide a compelling starting point for investors who want to try and smooth out the ride for their portfolios - both now and in the unpredictable years to come. We have used these convertible bond-related strategies as core holdings for asset allocation for decades.


John P. Calamos, Sr. is the Chairman, CEO and Co-CIO of Calamos Investments, and is the author of “Convertible Securities, the Latest Instruments, Portfolio Strategies and Valuation Analysis.” You can contact John at JPCsr@calamos.com.


The opinions referenced are as of the date of publication and are subject to change due to changes in the market or economic conditions and may not necessarily come to pass. Information contained herein is for informational purposes only and should not be considered investment advice.
©2010 NEOCORP MEDIA

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