Julien: First of all, yeah, there's less room for timing overall versus, let's say, bonds, but it also means that it makes for a very good quarter and your portfolio.
Chiara: Welcome to the ETF Experience podcast, where we unpack strategies, navigate turbulent markets. I'm your host, Candy Crowley. And today we dive into low volatility, investing a beacon of stability in chaotic times. I'm joined with Julien Palardy, managing director, head of Quantitative Investing, to get us started. 2025 has been a wild ride for the markets here today. We've seen significant volatility drive by U.S. tariff policies and concerns over the big beta food bill, which has raised fears of rising deficits and bond yields.
The S&P 500 peaked in February but fell nearly close to 20% by April. Among tariff announcements partially recovering by May 30th. And the VIX remains elevated, reflecting ongoing uncertainty. So, this volatility that we're talking about sets the stage perfectly for our focus today. Julien, can you maybe define market volatility for our listeners and explain why managing it is so critical for many for sure.
Julien: So essentially, the way people should probably think about volatility is that in the long run, equity at the very least, historically equity markets have been going up. So, think about the S&P 500 over the last 60 years. Maybe the annual return was in the range of 10% or maybe even 11%, including dividends. So, it's been very strong, but obviously those returns were not generated by with S&P 500 going in a straight line.
Right. That's not like it went up by this exact amount every year. And it's not like it went up like by 4.8% or 0.9 percent month after month to generate that. So, there are up and down movements and sometimes very, very strong on an annual or monthly or on a weekly or daily basis. And this is the consequence of the fact that information, new information here, the market comes in constantly.
And if you stand as of today, let's say, and look forward, there's tons of information about the future that you have no idea about. You have no visibility into this. And this is what we would call uncertainty or risk. And risk translates into market volatility. As the market ingests this information that comes out continuously. So, this is quite often what we call price discovery.
And price discovery doesn't happen anymore. It's not like the market is following a straight line. In fact, it's in order to digest this information, you get both good news and bad news as well. So, this is what triggers market movements. And managing that is really important because first of all, people tend to be risk averse, which means that they tend to and this can be questioned, by the way.
So, we can argue about this, but generally speaking, most people tend to prefer outcomes that are more certain as opposed to outcomes that are lesser. And now some of us like to go to the casino, but typically you don't want to gamble with your life savings, let's say, so you can use money to do it. But when it comes to all your assets, typically you prefer more reasonably certain outcomes then uncertain outcomes.
And on top of that, where the volatility is, it's not going to age properly. It can lead to fairly bad decisions. So, people tend to be emotional. They can pull out sometimes at the worst possible times. And those emotional decisions tend to be what's really the most expensive in a face of how you roll it down. Markets. People tend to make the worst decisions at the worst possible time.
Chiara: Yeah, I find, you know, the word uncertainty has been the word that you often hear navigating these markets with all the Trump tariff situation and negotiations that we've seen. And, you know, back in April when we saw the market or the S&P 500 dropped double digits, those clients that pulled out got hurt the most. Right? So, this strategy of low volatility equities or strategies help mitigate that that drawdown.
So, Julien, walk us through how do low volatility strategies mitigate these drawdown effects.
Julien: Low volatility strategies are essentially portfolios are built that are fully invested, first of all, in equity space and equity markets. And but they tend to emphasize low risk stocks. And there are certain industries or certain types of companies that tend to deliver more stable outcomes. And as a consequence, their price return also tends to be more stable. So those stocks tend to be favored by those strategies.
And it also those strategies also explode correlations between those stocks to deliver a stable outcome. And the consequence of this is that instead of seeing large movements in a market, let's say if you check your account and you're fully invested in equities, you could see that on some days you're down 5% or sequentially, you can be down a lot more.
And in this you can be down 20% over a sequence of a few a few days. And with low vol, typically this range is going to be a bit narrower, which means that and given the fact that there's going to be a more, more stable outcome, people will be less tempted to try to time to market as a consequence.
So, imagine that if you were invested in a T-bill, your returns would be fairly stable. In fact, nearly constant day after day. People are not tempted typically to move in and out of T-bills in an attempt to take the time short term and interest rates. Usually when it comes to equity markets, people are more tempted to move in and out because they're reacting as a consequence of their emotions and they feel like if things keep dropping further, they're going to get hurt more and they're going to see their life savings disappear and they tend to move out and then the markets could potentially rally and subsequently and they miss out on the those important rallies. So, by reducing volatility, you have a tendency to keep people more invested in a market. Now, at the same time, I'm not going to lie, some people look at the market than they feel like they would want to capture all of the outside and none of the downside. And unfortunately, people do tend to move out of low vol at the worst possible times as well and jump into the market because there's sort of our brain makes it tempting to try to capture those strong up movements and give up on that.
That's safer and strategy, safer assets. So in a way even cash strategies or T-bills, people would have a tendency to give up on those safe returns through to the buyer into the market, or maybe worse, like you could have cryptocurrencies or things like that where people just jump in because they hope that it's going to keep on going.
So unfortunately, you need to fight those and those tendencies as well. So, it's not it's not a bulletproof if approach. You want to keep people invested, but it's a that's a decent first step.
Chiara: I want to go back to the point where you said people get out of lowball at the wrong time, but before we get into that, maybe walk us through just general, how do lowball perform during, you know, the drawdown that we saw in April and then how do you low volatility performance usually is over the last 10 to 20 years.
Julien: Know what we've seen recently actually is extremely low down. I think after we we've seen different days some days, they didn't the downside capture was higher. But generally speaking, the episode that we've seen year to date was one that was essentially partly triggered by significant amount of the concentration in the markets. Obviously, the markets rallied more recently, but in the first episode, the first of all on that we've seen it was we've seen a pretty decent amount of market concentration because people were quite risk averse and as a consequence, they saw diversification in their portfolio.
And most of the names that suffered the biggest headwind, the largest market gaps and the most expensive names and more volatile names in the market and as a consequence, Low all did extremely well in that small episode of a broad down near their market crash, I would say. And it's not the first time that we've seen this in the last few years.
Julien: There's been those episodes, let's say in August of last year, July, August, where there was a drought on as well. There was that deep seek moment, as we could call it, where the markets crash most basically and via suffered. You know, vol did really well in that period. There was 2022 as well with the increase in inflation and the subsequent increase in interest rates, low vol did extremely well compared to the rest of the market because it was also an episode of the concentration of the markets.
I would say since 2020 and down markets, low vol has done insanely well. Sometimes there were periods where real vol at zero downside capture you and I wouldn't say that people should expect that going forward, but that it did happen quite a few times in the last few years. But it comes at less upside capture as well in strong market rallies like what we saw in 2023, 23, four.
And so that's the downside. You give up something to gain, there's downside protection.
Chiara: And again, the downside protection protects you from making those big emotional changes where, you know, you sell out when you see the market is down, you know, double digits maybe. Walk us through what is a good time to invest in low level is and when would be a good time to exit level.
Julien: Is going to sound a bit biased and a bit obvious coming from me. But the good time is the right time is always so it's a low vol is probably the best strategic choice that you can make when it comes to investing in equities. Again, because there's volatility management means that first of all, yeah, there's less room for timing overall versus let's say bonds, but it also means that it makes for a very good core in your portfolio because the Iraqi what do our service that global strategies tend to deliver returns that are very competitive actually with the rest of the market.
So even though they're made of more defensive equities, it contradicts they believe that less volatile equities should outperform more volatile equities in the long run. The empirical evidence shows the opposite, in fact. And as a consequence, you can limit the range of outcomes that you're going to get by investing in those equities much more. But in the long run, the average return is going to be I'm not going to say the same as the rest of the equities because it depends on market conditions that you face, but it's in the same ballpark.
The expectation should be roughly in the same the same range and as a consequence, on a risk adjusted basis, you do end up with much better risk adjusted returns with global equities. So, it forms a really good core. And for those who don't have an overall equities in their portfolios, they should certainly consider having that because even though we did see low vol underperformed quite a bit and strong up rallies that we've seen, concentrated rallies that we've seen in the last few years, If you look back over the last five years, actually since COVID, if we exclude you, one of COVID go vol have delivered really numbers in line with what you should expect
from equities in the long run. So, it's really about the equity market that's been extremely strong in that period. But no vol did deliver what you should expect from equities in the long run. And when's the right time to move out of low? Well, in my opinion it's essentially never. So, you can try to time it, or you can try to time high resources, low risk in the market.
But most people fail miserably at doing this. Not many people have been successful. So, it's a much better call, just like avoiding to time to market and just saying invest it. I would say try to stay invested in novel and as much as possible because actually to gone back on your previous question, what the returns have looked like or last ten years, as I mentioned, then maybe if you go back even further in the U.S., we've gone as far as nearly 100 years of data.
The numbers are in line with what you would see from the rest of the equity space. So, eight, nine, 10% and maybe even more actually more than eight nine. It would be more in the range of ten 11% than the U.S., for example. So, yeah, I would say stay as long as you can and try to fight back against your emotions or your temptation to move out to go for something riskier.
Chiara: Yeah, it's always when you least need it or when you think you least need it. You actually needed the most. Maybe walk us through how protecting from the downside helps with compounding benefits in your portfolio.
Julien: So essentially, for those who aren't familiar, you can have an average return for two securities or two portfolios, but you're not necessarily going to get the same component total return, sort of same wealth over time. So after 50 years that say the portfolio that says all that, that interesting is going to compound faster in the way you could think about this is if you have a drop of 50% in the value of your portfolio to recover fully from this drought, you're going to need a 100% return if only recover.
And obviously if you drop 5% instead, you're going to need like I'm not sure how much it is exactly, but it's close to 5%. That's not much higher than 5% that you need in terms of return to Earth to fully recover. And the obviously, the average return that you get for from both of those portfolios that I fully recovered back to zero is not going to be the same.
One is going to be much, much higher to compensate for the increased volatility. So essentially, you're going to need much stronger returns on average for more volatile portfolios to compensate to offset the impact that volatility is going to have on your long term compounded returns. And that let's call it the erosion of well, that's going to come with that.
So that's like just in terms of wealth accumulation, that's one reason to go for the less volatile portfolios on top of obviously all the all the bad decisions that people are going to tend to make over time if they have the more volatile eyes that don't portfolio.
Chiara: Not only do low volatility equities help, you know, give you some peace of mind, but also help you when it comes to compounding. Now, walk me through why investors should consider still investing in low volatility equities if they have a fixed income exposure in their portfolio?
Julien: You have all behaves very differently from fixed income. In fact, I would say that in terms of risk properties, people should reasonably think of low vol as a substitute for a balanced fund that is exposed to probably more to equities than to a fixed income, but let's call it maybe a 60, 40 or 7030 portfolio in favor of equities.
But the behavior of low vol is going to be different. So, there's going to be periods where fixed income is going to suffer much more. So, with 2022, for example, is a perfect demonstration of this and an environment where inflation and interest rates hit the market like we've seen the market had the stock market crash in that period.
But bonds also suffered very clearly because it was inflation driven. And in that same period, low oil actually did pretty well. So low level is not an option. It's not like, yeah, it's not going to behave exactly like a linear combination between stocks and bonds. And as a consequence, you're going to gain from diversification by holding low volume as opposed to just a cap weighted index blasting bonds.
And you're in your portfolio and who talks about diversification essentially implies also further reduction in risk. And the nearer benefit is obviously that if have all delivers market like returns or returns that are in line with long term expected returns of equities in the long run, probably they are going to outperform bonds as well. So, and consequently probably will outperform in a balanced fund also as a consequence.
So, there are multiple reasons why you would hold overall in your portfolio, even though you're going to have bonds to help you, what the downside level is going to be able to add to the risk reduction, but also add to your returns most likely, yeah.
Chiara: Sounds like low volatility equities are a great compliment to any portfolio and just equities in general. You know, before we end this podcast off, I want to take a moment to highlight the Quantum team at TD Management. I think, you know, the amount of data that you guys go through and just the quality of strategies that you guys have delivered is just a testament to all the skill set that we have there.
Maybe give us, you know, take the stage, talk to, talk to our listeners a little bit about the quant team and some of the innovations that you guys are working on.
Julien: So we worked on a lot of cool new stuff, but maybe it's worth mentioning first that we've been in that business for a very long time and I say we like I was not even part of this originally, but this group has been roughly in existence at 88, 96, since 96. And in fact, it was working before it got acquired and it was working on quant strategies even before that.
So, we have a long and rich history of building quant strategies, and everything started really with our strategy. So even though we're quite well known for our low volatility strategies, we only launched those low vol strategies. And in 2009, so before that we had alpha strategies and those strategies have been going, have been we've been running them for a, for a very long time.
So, we learned a lot throughout our history on how to build those strategies. We built infrastructure as well to support those strategies. We accumulated data of extremely high quality as well, point in time data in various markets and clean data as well, which is extremely important for common strategies. And today we have, I would say, two big families of strategies.
We have risk driven strategies, essentially low road and alpha strategies and their retail space. We call them our disciplined alpha funds and we have also a U.S. small mid-cap strategy. Get us them so where we apply or alpha models and then a smaller family of funds would be our dividend ETFs as well. And that actually are gaining quite a bit of momentum like their therefore our capital.
So, they can't gain down quite a bit of traction over the last couple of years. But these are not following our alpha models or risk models per se. It's more built as a custom, but, but I would say smartly built dividend, quant, quantitative slash, quality dividend strategy. So, these are the strategies that we have, and we keep pushing always the limits of both alpha and risk modeling by doing, for example, the AI and natural language processing.
We have our recent most recent hires actually all from the field of machine learning and artificial intelligence. And then we keep pushing in this direction to deliver our fine and risk reduction to our clients. So, we tend to be on the very edge of the research for risk modeling when it comes to application of machine learning. But in the alpha space we have a bit more competition.
But I do think we have a decent like our research pipeline. We have a lot of things that are actually moving into production right now in this space. So, and we have good collaborations also with the rest of the bank. So, there are groups that do specifically AI in the bank. I'm thinking year six, for example, that we acquired a few years ago.
We work with those, those in this team to, um, to build out from our roles and to work on different problems that our team is facing when it comes to managing money.
Chiara: Nice. Sounds like there's a lot of exciting stuff happening on the quant side. Julien Thank you for your insights into low volatility investing and TDs pioneering or pioneering TDs quantitative strategies. Thank you for your time today. Thank you to our listeners. I hope you consider low volatility ETFs like those at TD Asset Management can help strengthen your portfolios.
Thank you.
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