Volatility Managed Portfolios
Alan Moreira and Tyler Muir (Yale University)
June 18, 2016
Managed portfolios that take less risk when volatility is high produce large alphas, substantially increase factor Sharpe ratios, and produce large utility gains for mean-variance investors. We document this for the market, value, momentum, profitability, return on equity, and investment factors in equities, as well as the currency carry trade. Volatility timing increases Sharpe ratios because changes in factors’ volatilities are not fully offset by proportional changes in expected returns. Our strategy is contrary to conventional wisdom because it takes relatively less risk in recessions and crises yet still earns high average returns. This rules out typical risk-based explanations and is a challenge to structural models of time-varying expected returns.
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Correlations between asset classes have been trending up lately, a directional bias that could be a warning sign, according to several market observers.
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You can find any answer you want by comparing the current curve to various points in its history. Over the past 30 trading days, for instance, the curve is more or less unchanged. But comparisons over longer periods reveal a modest flattening.
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US economic growth estimates for the third quarter have been trimmed in recent weeks, but most analysts are still projecting a solid rebound. If the predictions are correct, output is on track to expand at the strongest pace in two years when the Bureau of Economic Analysis publishes the “advance” report for Q3 GDP next month.
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All the major asset classes posted gains last week, based on a set of ETF proxies. Thanks in part to another decision by the Federal Reserve to forgo an interest-rate hike, investor sentiment turned bullish, driving up prices for the five trading days through Friday, Sep. 23.
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● The Wealth of Humans: Work, Power, and Status in the Twenty-first Century
By Ryan Avent
Summary via publisher (St. Martin’s Press)
None of us has ever lived through a genuine industrial revolution. Until now. Digital technology is transforming every corner of the economy, fundamentally altering the way things are done, who does them, and what they earn for their efforts. In The Wealth of Humans, Economist editor Ryan Avent brings up-to-the-minute research and reporting to bear on the major economic question of our time: can the modern world manage technological changes every bit as disruptive as those that shook the socioeconomic landscape of the 19th century?
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Morningstar tells us that efforts at taming volatility in a multi-asset class framework generally turns up mixed results among publicly traded funds. Studying 60 products that are labeled “multiasset volatility-protection funds,” a recent Morningstar article reports that “as a group, volatility-protection funds do generally offer refuge when equity markets turn negative.” But it’s debatable if the extra cost and complexity that tends to define this group is worthwhile. As Morningstar notes, a simple blended index of 40% equities/60% bonds, which can be created with low-cost index funds, delivered superior downside risk management during periods when the S&P 500 fell.
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US economic output remained steady at a below-trend rate in August, based on this morning’s update of the three-month average of the Chicago Fed National Activity Index (CFNAI-MA3). Last month’s reading inched up to -0.07, the highest since Sep. 2015. But the slightly below-zero level reflects modest economic activity, which is in line with the data over the last several months.
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The Federal Reserve left interest rates unchanged yesterday, which Janet Yellen insisted wasn’t because the central bank is downgrading its outlook on the economy. Quite the contrary, Fed Chair Janet Yellen advised. “Our decision does not reflect a lack of confidence in the economy,” she said in a press conference on Wednesday. Economic growth is holding steady at a “moderate pace,” by her reckoning. But the Treasury market isn’t wholly convinced. Maybe that’s because the Fed’s economic forecasts were flat to slightly lower vs. the June projections.
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The US economy’s forward momentum remained sluggish in August. Although recession risk was low last month, a series of disappointing indicator updates in recent weeks suggest that the macro trend continues to struggle.
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