Bloomberg_Intech's Adrian Banner Uses Volatility to Beat the S&P 500_FINAL_exp.10.15.16

8/18/2019 Bloomberg_Intech's Adrian Banner Uses Volatility to Beat the S&P 500_FINAL_exp.10.15.16

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NOVEMBER 2015

PROFILE

NOVEMBER 2015

VOLATILITY REPRESENTS RISK for most in-

vestors. For Intech Investment Management, it’s

a source of return.

Adrian Banner, Intech’s CEO, says his firm doesn’tpick stocks, read brokerage research, look at funda-

mental data, or forecast individual stock returns. In-

stead, Intech’s team starts with a universe of stocks,

estimates their volatilities, and uses those num-

bers to come up with an optimized set of portfolio

weights. Each week, they rebalance to the weights.

Banner says the firm’s approach to investing is

based on research started more than 30 years ago

by its founder, mathematician Robert Fernholz.

“In 1982, he first had the realization that one could

build portfolios that should be more efficient than

a cap-weighted equity portfolio—without picking

securities,” Banner says. “It’s possible to do that

using only the volatilities and the correlations be-tween stocks.”

While that idea may still sound novel today,

there’s a lot of solid math behind it, Banner says.

“The challenge was turning that math into real port-

folios,” he says.

Intech started doing that in July 1987, when it

launched its flagship Intech U.S. Enhanced Plus

portfolio. Intech oversees about $51 billion in assets,

mostly for institutions. The 86-person firm is a sub-

sidiary of Denver-based Janus Capital Group.

Making VolatilityYour FriendIntech’s Adrian Banner uses math to capture gains fromprice swings.

STRATEGIES

BY JON ASMUNDSSON


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PHOTOGRAPH BY ROBYN TWOMEY

Adrian Banner, fundmanager, math whiz, and jazzpianist, tries out the piano atthe Carlton Hotel in New York.

ADRIAN BANNER

CEO,INTECH INVESTMENTMANAGEMENT

Aims to pick up excessreturn from volatility.

Uses math to optimize

portfolio weights.

Rebalances weekly.


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NOVEMBER 2015STRATEGIES PROFILE

Jon Asmundsson is Strategies editor of Bloomberg Markets.

[email protected]

WHEN BANNER, 40, was growing up in Sydney, Australia, he was

equally interested in music and math. He earned a Ph.D. in math

at Princeton University and joined Intech as director of research

in 2002. A jazz pianist, he sometimes plays before meetings at the

firm’s West Palm Beach, Florida, headquarters and has performed

at the Montreal International Jazz Festival.

Banner says In-

tech’s basic insight

is simple. Con-

sider a stock. Over

a couple of years,

its trend may be

up. Yet along that

general course, thestock will tend to

make a variety of

moves—zigzags above and below the trend. “So that’s volatility,”

Banner says. “And it can be harnessed—if one is willing to trade.”

The swings offer opportunities to buy low and sell high. The

way to do that, Banner says, is to first establish a policy for weight-

ing the stocks in a portfolio. Then, as prices move, rebalance back

to the weights. Rebalancing in essence buys low and sells high,

Banner says. “You’re selling previous winners, which by defini-

tion are high, and you’re using that capital to buy previous los-

ers,” he says.

How much juice can rebalancing add? Intech has worked that

out in its math. The key to it is compound return, Banner says.Let’s say you buy a stock for $100 and hold it for two periods. In

the first, it gains 25 percent. In the second, it drops 20 percent. The

average of those returns is 2.5 percent—pretty good.

The problem is that because you’d hung on to the stock over

the two periods, you actually ended up right where you started,

with a return of zero. The stock rose to $125 at the end of period

one and dropped back to $100—(20 percent of $125 is $25)—at the

end of period two.

Compound return “is what you actually experience with

buy and hold,” Banner says. In effect, volatility is a drag on

compound return when compared with average return. Mathe-

matically, compound return is approximately equal to the aver-

age return minus one-half of the variance. (Variance, a measure

of how widely a set of returns is spread around their mean, is the

square of volatility.)

You can break what Banner calls the “curse of compounding”

if you have more than one stock to work with. “What if you’re al-

lowed to dynamically allocate capital between two or more as-

sets?” Banner says. The compound return of a portfolio, like that

of a single asset, is the average of its returns minus one-half of its

variance. Thanks to modern portfolio theory—which Nobel lau-

reate Harry Markowitz set out in 1952—you can also describe the

portfolio return as equal to the weighted average return of its con-

stituent stocks. “Now, the plot thickens,” Banner says. The indi-

vidual stocks tend to have higher volatilities than the portfolio asa whole: So the average stock variance tends to be larger than

the portfolio variance.

IF YOU REARRANGE the terms of a couple of equations, Ban-

ner says, you end up with an expression that shows exactly how

much excess return you can get from rebalancing: It’s equal to

one-half times the weighted average stock variance minus the

portfolio variance. “That’s essentially the math formula that

shows how the variances and covariances contribute to the com-

pound return,” Banner says.

Rendered with a gamma and a couple of other Greek letters,

it’s also the master formula of what Fernholz called stochastic

portfolio theory. Fernholz originally got there by combiningstochastic calculus—“that branch of math that studies chang-

ing quantities like calculus but with a probabilistic component:

hence the fancy word stochastic,” Banner says—with modern

portfolio theory.

That may seem daunting. For Banner, though, it’s the alternative

that’s difficult: picking stocks that outperform. “We know that’s

very hard to do,” he says.

TRACKING S&P 500 VOLATILITIES

Adrian Banner says that smart-beta ETFs that equal weight their

portfolios tap into the same rebalancing gains that Intech seeks. “I believe

the equal weight is demonstrably capturing exactly the same effect,” he

says. Banner says, though, that equal weighting is not the best way to pick

up those gains. For one thing, the approach doesn’t take into account the

volatilities of the stocks.

JON ASMUNDSSON

VOLATILITY CAN

BE HARNESSED—IF

YOU’RE WILLING

TO TRADE,

BANNER SAYS.

mailto:[email protected]:[email protected]


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No investment strategy can ensure a profit or eliminate the risk of loss.

The proprietary mathematical process used by INTECH may not achieve the desired results. Since the Fund'sportfolio is periodically re-balanced, this may result in a higher portfolio turnover rate and higher expenses comparedto a "buy and hold" or index fund strategy. INTECH's low volatility strategy may underperform its benchmark duringcertain periods of up markets and may not achieve the desired level of protection in down markets.

Please consider the charges, risks, expenses and investment objectives carefully before investing. For aprospectus or, if available, a summary prospectus containing this and other information, please call Janus at877.33JANUS (52687) (or 800.525.3713 if you hold shares directly with Janus). You can also visit

janus.com/info (or janus.com/reports if you hold shares directly with Janus). Read it carefully before youinvest or send money.

The investing examples are hypothetical and do not represent the returns of any particular investment.

INTECH Investment Management LLC is a subsidiary of Janus Capital Group Inc. and serves as the sub-adviser on certainproducts.

Janus and INTECH are registered trademarks of Janus International Holding LLC. © Janus International Holding LLC.

INVESTMENT PRODUCTS ARE:

NOT FDIC-INSURED

MAY LOSE VALUE

NO BANK GUARANTEE

C-1015-102525 10-15-16 166-03-31871 10-15

Posted from Bloomberg Markets, November 2015, copyright by Bloomberg L.P. with all rights reserved.

This reprint implies no endorsement, either tacit or expressed, of any company, product, service or investment opportunity.

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Bloomberg_Intech's Adrian Banner Uses Volatility to Beat the S&P 500_FINAL_exp.10.15.16

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