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Lower volatility and long-term excess return

As an institutional investor, you are caught between the conflicting priorities of risk budget and return pressure. Your target return requires you to take on higher risks. We offer you a Smart investment solution: With our sustainable and risk-based portfolio optimisation (minimum risk), you gain degrees of freedom and action options:

  • Risk reduction with the same equity quota
  • Higher equity quota with the same risk - thus a higher return

Standard equity indices are not efficient

Standard indices weight equities by size (market capitalisation). Financial market research confirms that these indices do not have an optimal risk-return-ratio (Sharpe Ratio). Portfolios can be put together more optimally.

OLZ portfolio optimisation solves this problem.

We forecast the risk characteristics for each individual equity within an equity universe and from this we derive an optimally composed portfolio. Our target portfolio is the portfolio with the lowest risk or to put it more technically: The ex-ante minimum variance portfolio.

More robust portfolio: Thanks to improved diversification, risk-based portfolio optimisation leads to greater security. This manifests in lower risk and lower maximum losses.

Long-term excess return compared to market average: The minimum variance portfolio optimally captures the low-volatility premium. This results from the empirically proven fact that equities with low price fluctuations achieve above-average returns in the long term. This premium is not new but has been proven over several decades.

Sustainable investment with ESG integration

OLZ also incorporates ecological, social and ethical criteria (ESG Environmental, Social, Governance) into the composition of its portfolios.

Companies which do not meet key sustainability criteria are excluded from the investment universe (ESG exclusion criteria):

  • Companies which do not meet UN Global Compact criteria
  • Companies with the lowest sustainability rating
  • Companies involved in a serious controversy

In addition, particularly sustainable companies are given preference in OLZ portfolio optimisation and are more heavily weighted (ESG integration according to best-in-class).

For our investment process, we take into account MSCI ESG Research evaluations, a leading international provider of research and analysis in the area of sustainability.

Systematic investment process

When constructing a portfolio, we systematically follow a 3-stage investment process with no discretionary leeway for portfolio management.

Portfolio properties - comprehensible and predictable

The systematic optimisation of OLZ portfolios leads to a reduction in volatility and maximum losses. While outperformance can be expected in negative and volatile market phases, the defensive bias of the portfolio underperforms for the most part in highly positive markets with low-volatility. In sideways and slightly positive markets, OLZ strategies tend to outperform the benchmark.

How can I invest with OLZ?

Besides our our proven and successfully established strategies, client specific targets and restrictions (investment universe, tracking error, specific sustainability criteria, maximum weights, etc.) can be taken into account in the investment process for direct mandates.

Frequently asked questions (FAQs)

What is different about the MSCI Minimum Volatility Index?

OLZ has much more freedom in optimising the portfolio than the MSCI Minimum Volatility Index. While the latter has to adhere to a narrow bandwidth of +/- 5% for deviations from the benchmark, OLZ has significantly more scope for optimising its portfolio. The bandwidth for country and sector deviations ranges from 0% to +10% points relative to the benchmark. This enables OLZ to exploit the advantages of minimum variance optimisation with high degrees of freedom and the best possible liquidity.

How can the low-volatility factor premium be explained?

The low volatility premium (above average return from equities with low volatility) has been observed in the market for over 40 years. This market anomaly exists because the majority of investors are benchmark oriented. Market cap-weighted indexing is popular standard practice despite the fact that this investment behaviour does not lead to an efficiently diversified portfolio. Investing close to index minimises tracking error. Managers only tend to deviate from the benchmark when the reward (expected return) is significantly higher. This is why stocks with higher risk - high beta stocks - are favoured (overweighted), and stocks with low volatility are neglected (underweighted). As a result, low volatility stock prices fall and their expected returns rise, which contributes to the low volatility premium. In recent years, the trend towards passive implementation of the market cap-weighted index has in fact increased the low volatility premium.

Can a minimum variance portfolio be characterised by 'value'?

Scientific studies confirm that minimum variance portfolios do not correlate with the value factor. Low volatility and value are two complementary factor premiums. The two investment styles can be combined, and together they yield a robust alpha compared to the market cap-weighted index.

Will the low volatility premium persist?

Generally, the structures and processes to which institutional investors are subject only permit slow changes. It takes advanced know-how, courage and strong governance not to follow the herd but instead, to stray from standard behaviour. Developments in recent years show that more and more investors - both institutional and private - invest according to the standard index or the average portfolio. The standard behaviour of the majority - replicating the market cap-weighted index - means that the low volatility premium does not disappear. In fact, it can be observed that the premium is increased by this behaviour.

What if all investors were to invest according to the minimum variance portfolio?

If all investors were to invest in the minimum variance portfolio, the excess return (low volatility premium) would disappear. However, the portfolio would still be composed more efficiently and with better diversification than the market cap-weighted index. With the same expected return, an investor who invests in a minimum-variance portfolio would benefit from significantly lower volatility and fewer losses from market corrections.

Could a minimum variance portfolio lead to extreme solutions?

When optimising, maximal limits for individual stocks, countries and sectors (known as restrictions) are taken into consideration, thus avoiding concentrations. Compared to standard 'minimum variance' indices such as the MSCI Minimum Volatility Index, OLZ minimum variance portfolios have considerably more degrees of freedom. For example, OLZ does not use minimal weights.

Does including sustainability criteria lead to lower returns?

No. The risk-return characteristics of our strategies are not affected by the implementation of sustainability criteria in the investment process. Sustainability can be implemented particularly well with a risk-based investment approach such as OLZ minimum variance: It does not lead to a decline in returns nor does it weaken the investment approach: The investment universe remains sufficiently large, especially since companies whose share prices only fluctuate a little are often also prudently managed. In short, minimum variance and sustainability harmonise optimally. Further information on the integration of sustainability criteria can be found in our OLZ research note: «Minimum Variance - a Harmonious Relationship».

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