We’ve planted the seed for our volatility journey. We discussed in our initial note – Volatility is Here to Stay. We talked about the risky nature of the 60/40 stock/bond portfolio. And we even shared a potential solution with the multi-asset approach to portfolio management. Now it is time to take a deeper dive into the unknown.
The Great Debate
One could ask – Why should I even care? Why waste time on this topic if it is so complex and hard to capture? All fair questions, but when we see global assets moving in sync, and it feels like correlations keep inching higher (everything moving together), we tend to want hedges of sorts. For these reasons and more, we favor the exploration of volatility.
State of Play
Due to the complexity of the topic, we have some of the sharpest minds in the business providing research, ideas, and hedging alternatives against the volatility monster. After the 1987 crash, the tail funds became all the rage. The tail funds in their simpler form will buy puts on the market. This is an expensive alternative, and we now have several other funds, strategies, and products to access volatility. There are several volatility ETFs (Exchange Traded Funds), we have volatility funds, VIX options, VIX futures, and several new products and players incorporating optionality into their portfolios to help manage risk.
The volatility space has an interesting tailwind, as assets into the above strategies continue to grow. It could have a lot to do with the volatility genie coming out of the bottle in February 2018, when the market moved fast enough to have the XIV (a volatility fund) shut down. That marked the end of an extreme low-point in volatility in the general markets. The volatility trends are higher, the increase in rates and inflation support the “newer” vol trend, and the recent day-to-day action makes volatility a bit more palpable.
We now have more volatility and more solutions. That is the good news. The challenge is to figure out what works and what fits our portfolios.
Our Journey
We (at C&P) have been exploring volatility for 30-years: studying, teaching, and managing derivatives risk for large banks and institutions. It is our beat. The world of the unknown makes this fun and imaginative. “Tail talk” is a popular topic and gets a lot of attention both inside and outside the markets arena. One of our goals at C&P is to try to simplify to better understand volatility. We’ll try to have some fun as we take you on a journey towards volatility solutions.
Disclaimer: The information contained in this article is for informational purposes only and should not be considered as investment advice. The information presented in this article should not be interpreted as a recommendation to buy, sell or hold any security or investment. Before making any investment decisions, it is important to do your own research and seek advice from a qualified professional. Investing in securities and other financial instruments carries a high level of risk and may not be suitable for all investors.
