Defining a New Framework for Equity Investing

Equity investing is facing a crisis of confidence. After several years of high volatility, disappointing returns and the failure of conventional diversification, the fear of equities is pervasive. After all, how can anyone rely on equities to meet future targets when extreme market turmoil can destroy years of careful planning in a heartbeat?

I think this question warrants a new way of thinking about equities. The traditional framework of investing by style and market capitalization is evolving toward an enhanced paradigm in which benchmark sensitivity and appetites for absolute risk will determine equity strategies (Display 1). Seen through this prism, there are more ways than ever to deliver long-term returns while managing short-term volatility in portfolios and allocations of portfolios.

This article is the first of several that present research we’ve done to help define a new framework for equity investing. We believe this framework can help align the diverse needs of clients with an increasing array of equity strategies available today.

By taking a closer look at what strategies worked during the market meltdown, we have developed a greater appreciation for the intricate fabric that defines the risk/return profile of different types of stocks. For example, the performance of certain types of stocks can vary over different time periods and in different market environments. And risk management is no longer just a defensive tool—effective risk budgeting can be used to generate better returns.

I believe that our framework reflects a more complete picture of equity investing, across a two-dimensional spectrum (Display 2). In the upper right quadrant, traditional style strategies offer the prospect of higher long-term returns, though absolute risk is high and performance is closely tied to the benchmark. Moving to the upper left-hand quadrant, strategies that provide more stability can help manage absolute risk by offering equity-like returns and alpha that is uncorrelated with traditional strategies.

Some investors may prefer to mitigate absolute risk by deviating more sharply from benchmarks. Higher benchmark sensitivity means that most of the return comes from market movements. In contrast, long/short strategies—in the lower left quadrant—are less benchmark-sensitive, so most of the return comes from stock selection. Long/short equities are also less correlated with traditional equities. Similarly, concentrated equities are less driven by benchmark movements, though their focus on a small number of stocks or a single industry may add to the risks.

The right combination of strategies really depends on a client’s needs and risk appetites. For example, institutional investors are grappling with pension fund deficits and new regulation that forces them to fund liabilities more often, making volatility more punishing. Individual investors are living longer than ever; they need strong equity returns, but the fear of stocks is pervasive.

We believe that our enhanced framework for equity investing can help investors overcome their fear of equities and provide an effective response to their needs, to navigate changing market conditions with confidence. In my next blog post, I’ll show how different types of equities have performed in different volatility environments.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio-management teams.

Sharon Fay is Head of Equities at AllianceBernstein.

Sharon Fay

Sharon E. Fay was named Head of AB Equities in July 2010. She is responsible for overseeing the portfolio management and research activities relating to all growth and value investment portfolios. In addition, Fay serves as CIO of Global Value Equities, overseeing the portfolio management and research activities related to cross-border and non-US value investment portfolios. From 1999 to 2006, she was CIO of European and UK Value Equities, serving as co-CIO from 2003 to 2006 after being named CIO of Global Value Equities in 2003. From 1997 to 1999, Fay was CIO of Canadian Value Equities. Prior to that, she had been a senior portfolio manager of International Value Equities since 1995. Fay joined the firm in 1990 as a research analyst, subsequently launching Canadian Value, the firm’s first single-market service focused outside the US. She then went on to launch the company’s UK and European Equity services and build Bernstein’s London office, home of its first portfolio management and research team based outside the US. Fay holds a BA from Brown University and an MBA from Harvard Business School. She is a CFA charterholder. Location: New York

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