No sugar coating it - 2020 was a challenging year for quantitative investing

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2020 proved to be a difficult year for systematic investing. Quantitative models that rely on historical data did not fare well over the past year, as the COVID-19 Pandemic wreaked havoc on both the global economy and financial markets.

In contrast to most quantitative strategies, that seek to find companies with stable earnings and attractive valuations, Low Volatility investing does not rely on traditional valuation metrics directly but rather tries to exploit anomalies in how investors perceive risk. Nonetheless, the investment strategy was also adversely impacted in both absolute and relative terms during the year.

To help provide some clarity and context as to how and why systematic investing strategies underperformed during 2020, the Quantitative equities team at TD Asset Management Inc. (TDAM) recently published their 2020 Year in Review and Look Ahead article. In it, the team dissects some of the main drivers of the absolute and relative underperformance for the year and what we can expect in 2021.

What happened?

Our Low Volatility Strategies underperformance, in both absolute and relative terms, was disappointing. Few people saw the COVID–19 Pandemic coming, yet some active managers, who were overweight growth sectors, were lucky to benefit from the pandemic despite being similarly caught off guard by it. Moreover, some passive managers who rode the wave of drawdowns and runups also ended up benefiting when compared to active managers who tried to protect their clients from this turbulence by trading the portfolios.

Luck - good or bad - played a large role in what transpired in 2020 for investment managers, but we firmly believe that we our strategies are on the proper footing for 2021. Going forward one should ask to what extent central banks can continue to bail out investors by managing market turbulence and how much fiscal stimulus will be available without putting public finances under unbearable stress.

Expectations for the near-term

Typical market crashes and rallies are led by more volatile equities. Stock market performance in 2020 was far from typical. Investors in TD Low Volatility Equity funds have not experienced the downside market protection they have come to expect. Thus far, they also have not participated as much in the narrowly based yet strong market rally since the end of March 2020.

The greater the underperformance, the more investors of our various Low Volatility investments understandably question their investment decisions. While our funds hold many equities that are currently out of favour, we believe that now is not the time to sell them and invest in recent winners, many of which now trade at very high multiples of forecasted earnings.

2021 and beyond

As of year-end 2020, yields on 10-year U.S. Treasury bonds and Government of Canada bonds are near 1%. These yields are historically very low, especially when compared with the 2% inflation targets of the U.S. Federal Reserve and the Bank of Canada. Extremely low interest rates are bound to lead many investors to review their strategic asset allocations in favour of equities.

As investors increase their exposure to equities, many will discover that less volatile equities trade at reasonable multiples of forecasted earnings and pay dividend yields far in excess of government bond yields. As a result, we expect 2021 to be favourable for Low Volatility equities.

The information contained herein has been provided by TD Asset Management Inc. and is for information purposes only. The information has been drawn from sources believed to be reliable. The information does not provide financial, legal, tax or investment advice. Particular investment, tax, or trading strategies should be evaluated relative to each individual's objectives and risk tolerance.

All products contain risk. Important information about the pooled funds is contained in their respective offering circular, which we encourage you to read before investing. Please obtain a copy. The indicated rates of return are the historical annual compounded total returns of the funds including changes in unit value and reinvestment of all distributions. Yields, investment returns and unit values will fluctuate for all funds. All performance data represent past returns and are not necessarily indicative of future performance. Pooled fund units are not deposits as defined by the Canada Deposit Insurance Corporation or any other government deposit insurer and are not guaranteed by The Toronto-Dominion Bank. Investment strategies and current holdings are subject to change. TD Pooled Funds are managed by TD Asset Management Inc.

Certain statements in this document may contain forward-looking statements (“FLS”) that are predictive in nature and may include words such as “expects”, “anticipates”, “intends”, “believes”, “estimates” and similar forward-looking expressions or negative versions thereof. FLS are based on current expectations and projections about future general economic, political and relevant market factors, such as interest and foreign exchange rates, equity and capital markets, the general business environment, assuming no changes to tax or other laws or government regulation or catastrophic events. Expectations and projections about future events are inherently subject to risks and uncertainties, which may be unforeseeable. Such expectations and projections may be incorrect in the future. FLS are not guarantees of future performance. Actual events could differ materially from those expressed or implied in any FLS. A number of important factors including those factors set out above can contribute to these digressions. You should avoid placing any reliance on FLS.

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