Myths surrounding market volatility need to be busted in order to enhance portfolio returns, says research and investment firm Triple3 Partners.
According to Triple3 Partners chief executive Simon Ho, there are a number of “persistent myths around volatility” that obscured the “true nature of volatility and its impact”.
“Probably one of the most persistent volatility myths of recent times is that markets have been volatile and that investors need to be cautious,” Mr Ho said.
He pointed to the VIX index that measured expected volatility on the S&P500 Index across the subsequent 30 days, with high VIX readings indicating investors should anticipate sharp market movements.
“In fact, the VIX index shows the recent period since 2015 has been the most non-volatile periods of the market’s history,” Mr Ho said.
“Tracking a synthetic VIX index that has been created to track back to 1928, we find that market volatility is in fact at 100-year lows.”
Mr Ho said the VIX, which was currently at an “unprecedented” level of nine, had “never been lower”.
“There hasn’t really been a less volatile period since the S&P began,” he said.
Another myth was the belief that “volatility is bad for investor portfolios”.
Mr Ho acknowledged that while there was “no question” that volatility would not be good for long-term investors, volatility as an asset class was another matter, offering “a largely untapped source of alpha that can offset losses in the underlying portfolio”.
“As an asset class volatility is good for a portfolio in that it is highly negatively correlated to equities,” he said.
“Market volatility creates opportunities for investors who short the market, and who make a call on which shares will fall in value – as well as which shares will increase.”
Mr Ho also said that, instead of staying out of the market, volatility was in fact “a great opportunity to generate alpha in the VIX futures and options market”.
“VIX today is front and centre of the conversation in major markets around the world and volatility options are in fact driving investors into the market,” he said.
“Interestingly, it is retail usage of these products – particularly exchange traded products – that has driven this seismic growth.”
Finally, the belief that volatile markets were an indicator of a ‘bubble’ forming was “the exact opposite” of true, Mr Ho said.
“Volatility is usually associated with a piercing of the bubble as opposed to a harbinger of the bubble,” he said.
“Non-volatile markets – such as what we are experiencing now – are more likely to indicate a bubble is forming.
“For instance, while there is no volatility in the share market, definite bubbles are forming in bond markets and with house prices.”