Volatility Managed Portfolios…

A long time ago, while working at EDF Man (ok a long, long time ago), I had a conversation with a futures fund manger who managed a few billion dollars using basic trend following computer programs (he described it as coin flipping)… He said that not only might an adverse price move kick him out of a market, but an increase in volatility above some threshold would too… The reason, he said, was that he lost confidence in the ability to manage risk in increasingly volatile markets… I thought of that conversation when I saw this paper by Alan Moreira and Tyler Muir, http://faculty.som.yale.edu/tylermuir/documents/VolatilityPaper237.pdf

Here is their conclusion:

“6. Conclusion
Volatility managed portfolios offer superior risk adjusted returns and are easy to implement in real time. These portfolios lower risk exposure when volatility is high and increase risk exposure when volatility is low. Contrary to standard intuition, our portfolio choice rule would tell investors to sell during crises like the Great Depression or 2008 when volatility spiked dramatically so that investors behave in a“panicked”manner. We conduct welfare implications for a mean-variance investor who times the market by observing the conditional mean and conditional volatility of stock returns. We find such an investor is better off paying attention to conditional volatility than the conditional mean by a fairly wide margin, suggesting that volatility is a key element of market timing. Finally, we study extensively the volatility timing decision for long horizon investors.”

The crude oil market moved from an implied volatility of just below 13% in early 2014 (a record low) to around 80% last year…  I’n guessing that “yield enhancement” strategies did not do so well without a volatility stop…