Quality Can Deliver in Times of Rising Rates

As talk of an early Fed “tapering” triggered a sell-off in bonds, safe-haven equities have also suffered. Can low-volatility strategies survive rising rates and an unraveling of the safety trade, in which investors rushed headlong into safe assets no matter the cost? We say, yes—but you’ll need an active approach to navigate the near-term pitfalls.

Some corners of the low-beta universe have become overcrowded and pricey as ultralow rates drove an intense hunt for yield. High-dividend-paying and traditionally defensive stocks, for example, are trading at some of the richest valuations of the past 20 years. This leaves them vulnerable to a recovery-induced rise in interest rates, which would favor cheaper, racier cyclical stocks.

But we view the low-volatility opportunity more broadly, and with a stock picker’s eye.

Unlike passive low-volatility index-tracking strategies and ETFs—which are prone to risky concentrations in popular stocks—active strategies can steer clear of these overpriced pockets and lean more heavily on more attractive opportunities elsewhere in the space.  

And opportunities are out there. Our research shows that combining low beta with traits of fundamental quality—which we define as high, sustainable profitability, strong return of cash to shareholders and good capital stewardship—is even more powerful than targeting either component on its own. Why? Because low volatility and quality factors tend to work best at different times: when one is facing headwinds, the other provides support.

This complementary tag-teaming has been particularly beneficial in past periods of above-trend rises in 10-year US Treasury yields (Display). The highest quality quintile of stocks strongly outperformed a generally buoyant global market. As would be expected, the lowest-beta quintile trailed, although our research found that this underperformance tended to narrow, the longer rallies ran (a rising tide lifts all boats).  

As important, quality hasn’t attracted big crowds like other parts of the low-volatility world. For instance, the stocks of highly cash-generative companies are trading at historically low price/forward earnings multiples and at some of the biggest discounts to the market since 1990 (Display below, top), reflecting worries that this cash will be ill-spent. Companies with aggressive stock buybacks also look reasonably priced versus history (Display below, bottom).


Active strategies can adjust exposures depending on insights into current fundamental attractiveness and risk, even pivoting into sectors not typically associated with low volatility. For instance, we’ve found attractive opportunities in technology services companies with large installed bases and low capital needs, and in nonlife insurers that offer stable industry conditions, good capital discipline and diversification owing to the unique nature of their risks. Within healthcare, a classic low-beta sector, we favor large, diversified pharmaceutical companies, which are still selling at big discounts to the market, and we avoid erratic, event-driven biotech firms.  

Turning points in interest-rate cycles are messy, and divergent growth expectations around the world are adding to the uncertainty. With markets likely to remain volatile for some time, we think an equity strategy offering systematic downside defenses should continue to hold broad appeal. Active approaches can add value in a variety of environments and can be used to meet a variety of investor objectives within an overall portfolio. In our view, stability deserves a permanent place in most investors’ portfolios.   

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.

Christopher W. Marx

Portfolio Manager—Equities
Christopher W. Marx is Portfolio Manager of Equities. He joined the firm in 1997 as a research analyst, covering a variety of industries both domestically and internationally, including chemicals, food, supermarkets, beverages and tobacco. Marx joined the portfolio management team in 2004. Prior to joining the firm, he spent six years as a consultant for Deloitte & Touche and the Boston Consulting Group. Marx holds a BA in economics from Harvard University and an MBA from the Stanford Graduate School of Business. Location: New York

Kent Hargis

Portfolio Manager—Strategic Core Equities
Kent Hargis is Portfolio Manager of Strategic Core Equities. He has been managing the Global, International and US portfolios since their inception in September 2011. Hargis was named Head of Quantitative Research for Equities in 2009, with responsibility for overseeing the research and application of risk and return models across the firm’s equity portfolios, and is currently Co-Head of Quantitative Research. He joined the firm in October 2003 as a senior quantitative strategist. Prior to that, Hargis was chief portfolio strategist for global emerging markets at Goldman Sachs. From 1995 through 1998, he was assistant professor of international finance in the graduate program at the University of South Carolina, where he published extensively on various international investment topics. Hargis holds a PhD in economics from the University of Illinois, where his research focused on international finance, econometrics, and emerging financial markets. Location: New York

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