Your portfolio
[ NORMAL VOLATILITY ]
20 / 21
NUMBER OF DAYS S&P 500 MOVED MORE THAN 1%
“Insofar as investors are normally
positive, reflecting a rising equity
market over time, one could
characterise the mood of investors
as fluctuating between confidence
and greed, punctuated by moments
of fear,” he says. “This is reflected in
volatility, where we have extended
periods of subdued volatility.”
Teahan adds that spikes in
volatility represent crises in investor
confidence, either driven by real or
perceived increases in underlying risk.
Many investment models associate
volatility with investment risk but this is
something Ilan Chaitowitz, co-manager
of the Nomura Global High Conviction
strategy, takes a firm view against.
“We think there is a relationship
between volatility and investment
risk, but indirectly,” he says.
“Higher volatility of asset prices
can drive behavioural biases, which
can lead to mistakes – and that’s an
investment risk. But in and of itself,
“A low VIX reading gives
no insight into underlying
risks building in the equity
market – it does not reflect
valuations, leverage or risks
to earnings”
FE TRUSTNET
Daily moves in equities
140
120 140
120
100
80 100
80
60 60
40 40
20
0
1990 20
1994
1998
2002
2006
2010
2014
2018
0
Source: Janus Henderson/Bloomberg
Notes: Blue bars show the number of days in a year when the S&P 500 has moved up or down by more than 1%,
pink bar shows 2018.
whether the asset price fluctuates or
not isn’t an investment risk.”
Fear gauge
The most commonly used measure
in professional investment and
economic circles is the CBOE Volatility
index, or VIX, launched in 1993. This
is a live-traded index that measures
implied volatility in the prices of a set
of put and call options on the S&P 500.
“In other words, a measure of the
market’s expectations for asset price
movement,” explains Srivatsa.
As it is solely a forward-looking
outlook on the movement of the
US’s 500 largest stocks, is it the most
accurate reading of global financial
volatility? Up to a point, says Srivatsa.
He adds that, given it has a 30-day
view, is quick to reflect change and is
tradeable, the VIX can be a useful tool
for investors. However, he points out
it does not give the full picture.
“Beyond the fact that it is only linked
to the S&P 500 – a large and important
market, but still only one part of the
global equity universe – it is also short
term, based on options which expire
in 30 days,” he explains. “Looking at
longer-dated options will often present
a more nuanced picture of market
expectations, as will looking at other
market dynamics such as option skew,
which can highlight prevalent market
sentiment or hedging demand.”
As a relatively blunt instrument, the
VIX index is a better indicator of current
market sentiment, according to Teahan.
“However, if one was looking for an
indication of risk, then equity volatility
and the VIX are poor indicators,” he
says. “A low VIX reading gives no
insight into what underlying risks are
building in the equity market – it does
not reflect valuations, leverage or risks
to earnings.”
Never had it so good
Such a prolonged period of low
volatility means many investors may
have forgotten what it is like to live
through more erratic periods.
“In 2017 and early 2018, many
measures of complacency were
apparent,” says Teahan.
However, Srivatsa reminds investors
that volatility works both ways.
“Over the long term, investors rely
on volatility to generate returns,” he
says. “So, it’s an essential ingredient
for any investment strategy built on
market exposure.”
trustnet.com