TDAM Talks ETFs Podcast: The Upside of Risk Reduction - Navigate Uncertain Markets with Low Volatility ETFs

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ANNOUNCER: TD Asset Management welcomes you to this week's podcast. As a reminder, this podcast cannot be distributed without the prior written consent of TD Asset Management. 

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TOM GRANT: Hello and welcome to TDAM Talks ETFs. My name is Tom Grant. And I'm the ETF Capital Market Specialist here at TD Asset Management.

Today, I have the pleasure of discussing low-vol strategies that are part of the TD ETF suite. To help me do that, I have a special guest. It's Jacqueline Kwok, who is a Client Portfolio Manager on the quantitative team at TDAM.

How are you doing today, Jacqueline?

JACQUELINE KWOK: I'm doing great. Thanks for inviting me on this podcast.

TOM GRANT: Well, we are certainly happy to have you. And I think the topics we're going to discuss today are certainly things that people are going to want to hear about given the recent volatility in the marketplace. And speaking of that, there's certainly a lot of it these days. What are the main contributors to the recent rise in volatility.

JACQUELINE KWOK: Yeah, it's been a tough start to the year for equities for sure, especially for growth stocks. I would say inflation and the invasion of Ukraine to be the big headline news that is creating a lot of uncertainties for stocks these days. So this inflationary environment that we're in has not improved. We continue to hear about supply chain issues going into 2022. And some people might not have felt the impact of higher prices last summer. But by now, we can clearly see how much more we are paying for gas and groceries.

Now adding to the situation you have the Russia-Ukraine war that posses upside risk to inflation, because now we're seeing even higher energy and commodity prices. And with inflation being a global issue, most central banks have begun hiking interest rates to combat inflation. Of course, this is not good news for growth stocks, where valuations were stretched to begin with. And so we saw tech stocks sell off early on. So that debate, at this point, is how high and how long this tightening cycle will be. And if they hike too fast or too much, then it introduces the risk of putting the economy in a recession. And I think all of this puts us in a very volatile period for investors.

TOM GRANT: Well, it certainly sounds like there's a lot of moving parts out there. And certainly that contributes to our portfolios jumping around or my portfolio jumping around, which is not necessarily something I always like to see. How does a low-vol strategy help with this?

JACQUELINE KWOK: Yeah, I don't like volatility myself. So I think when markets experienced heightened volatility, investing in a low-vol solution makes a lot of sense because it can help reduce the overall volatility of your portfolio. So unlike other strategies that focus on generating returns, the goal of a low-vol strategy is to provide market-like returns but with much less volatility than the market.

So in other words, we want to capture less downside when markets are down and participate in some of the upside when markets rally. And this could lead to a better risk-adjusted return and strong long-term performance. So overall, it's a much smoother ride for investor, I would say.

TOM GRANT: So certainly there's been a lot of volatility to start the year. So how is the strategy performed so far?

JACQUELINE KWOK: I'm glad you asked that. Timing is good for the low-vol factor given what's going on in the markets these days. About this time last year, our low-vol strategies have performed extremely well. And that momentum has continued into this year. In general, we saw very low downside capture ratios and a high upside participation.

When we looked at the rolling 12-month performance, for example, at the end of February, our portfolios generated between 5% to 8% of outperformance, depending on the region we're looking at. And so far this year, these portfolios continue to perform very well.

TOM GRANT: So let me just dig into the low-vol strategy a little bit more. What factors do you look for when constructing a low-vol portfolio? Is it sector specific or what do you guys look for?

JACQUELINE KWOK: Yeah so the portfolio invest in stocks that are less volatile. And we have limited or no exposure to risky stocks. So basically, it is defensively positioned to protect against market drawdowns by favoring sectors such as utilities and consumer staples. In terms of portfolio construction, this is a bottom-up quantitative approach. So we use a proprietary risk model that was developed by the quant research team to forecast risk. And we use that information along with trading costs, and sector, and security level constraints to generate an optimized portfolio.

The key input is the risk model. And there are low-vol portfolios out there that use simple risk model, which invests in stocks with the lowest beta. Now our risk model is more advanced. In addition to looking at individual stock prices, it also looks at the correlation between individual stocks and select those stocks that have low correlations. In other words, they move in opposite directions of one another. So we end up with a portfolio that is better or I guess I would say more effective at reducing risk.

TOM GRANT: Sounds pretty good. So what type of investor-- and obviously I'm attracted to this strategy-- but what type of investor would generally prefer a low-vol strategy?

JACQUELINE KWOK: I would say there are a number of reasons that a strategy like this would be attractive to investors. Let's say if you are a risk-averse investor and want some exposure to equity returns. A low-vol strategy could provide an entry point to equity investing. Then there are investors who are looking for a smooth market experience where they don't have to worry about market timing.

It's hard to predict market sell-off. And as such, investors often tend to sell low because they waited too long to sell. And they tend to buy high because they've waited too long after the markets have recovered to get back into the game. So by investing in low-vol solution, investors typically would lose less on the downside and can remain invested for longer, which allows them to participate when markets eventually rally again.

And lastly, I would say given the recent market volatility, equity investors who are looking to de-risk their portfolio and protect their gains-- they could allocate a portion of their equity exposures to low-vol instead of moving to bonds where returns are generally a bit lower at this point. But I think overall, as an investor, it's always good to reevaluate your exposure and have a strategy that helps manage risk in your portfolio.

TOM GRANT: Now I just want to shift gears just a little bit here. TD's Wealth Asset Allocation Committee has a view that is very, very supportive of our home country. Can you tell me a little bit about why we're so bullish on Canada these days?

JACQUELINE KWOK: Yeah, so there are a couple of reasons why Canadian equities would be a good place to invest right now. If we take a look at our current situation where rates are going up and commodity prices are elevated, the sectors that stand to benefit the most would be financials and energy stocks because these companies may be able to deliver sustained earnings strength. Now on the other hand, higher rates typically are not a favorable for growth areas such as tech stocks.

So far this year, the energy sector is up more than 40%. And I think financials are up almost 2%. But then when you look at tech consumer discretionary and telecommunication services, they're all down between 5% to 10%. So this is why we're seeing the S&P 500 and even the NASDAQ benchmarks being down this quarter. On the other hand, the TSX is up more than 4% because, in Canada, financials and energy stocks make up a larger allocation within the benchmark while tech has a smaller allocation. So therefore, Canadian equities would be an attractive space for investors in this environment.

TOM GRANT: For investors looking for low-vol solutions, what does TDAM have on the shelf? And I guess follow up question would be, how do we differentiate from our competitors?

JACQUELINE KWOK: So when it comes to low-vol investing, TDAM has built a very successful franchise in the low-vol space. We were one of the first managers to offer low-vol strategies to investors and have had a long track record of 10 plus years managing these type of strategies for both institutional and retail clients on the mutual side of things.

That said, we currently offer three low-vol ETFs. So we have the Systematic International low-vol ETF that was launched about five years ago. And we recently launched both the US and one Canadian low-vol ETF about three years ago. Now these are all active ETFs that are managed under the quant team.

And just to highlight our capabilities in this area, we have a dedicated data team that builds and maintains our database rather than relying on external data providers. We have our own research team that conducts ongoing research and, as mentioned earlier, we use a proprietary risk model, which gives us more flexibility to implement our own views on risk compared to using a commercial one. And then, we have our team of PMs who actively manage to portfolios on a daily basis.

So overall, we have a very big team with lots of expertise, and skill sets, and certainly a lot of collaboration within the team. In terms of performance, all three ETFs have performed well year-to-date. But if you're bullish on Canada and are always worried about market volatility, then I think allocating parts of your portfolio to the Canadian low-vol ETF would be something to consider because our defensive positioning could provide a cushion when markets are down. And the portfolio has limited exposure to tech stocks. And despite not having much energy stock, it does offer exposure to financial stocks.

TOM GRANT: So those three symbol-wise-- for the Canadian ETF it's TCLV is the symbol. For the US it's TULV. And for the International it's TILV. Any closing comments, Jacqueline, that you'd like to share with us or something that we may have missed earlier on?

JACQUELINE KWOK: Yes I do have something I want to share quickly. And that's you mentioned that in addition to our low-vol ETFs, we also offer two dividend ETF strategies and two multifactor ETFs. So unlike low-vol, these are focused on alpha generation. So in total, we have seven quant ETF solutions. And they all have been doing extremely well. And I think it's worth taking a look at these offerings.

TOM GRANT: All right, Jacqueline. Well, thank you so much for taking the time to dive into these ETFs with us today. For all of you listening, we thank you for tuning in.

For more information on our ETFs, please visit TD.com/ETFs. And follow us on Twitter at @TDAM_Canada. Or, you can also check us out on LinkedIn under TD Asset Management to stay up-to-date on all the ETF-related podcast, blogs, and so much more.

Lastly, if you have any comments or suggestions on what you'd like to hear more of, please email us at TD.TDAMTalks@TD.com. Thank you for listening and have a great rest of your day.