Multi Asset June 2017  

The pitfalls of volatility

This article is part of
Guide to multi-asset investments

The pitfalls of volatility

Volatility has been in the news a lot recently as the Volatility Vix index, a measure of fear in the stockmarkets, has been at near-record lows.

In May, the Vix fell to 9.65, dabbling at the all-time low set by the index on 23 December 1993, when it was reading 9.17.

Michael Baxter, economics commentator at The Share Centre, notes: “Since the index was launched in 1990, the average reading has been 19.5. The index peaked in 2008 with a reading, at close, of 80.06, and closed at 42.99 on 10 August 2011. 

“However, over the last 12 months or so volatility has been low, with mild exceptions during the EU referendum and US election. The index closed at 25.76 on 24 June last year – a 12-month high and also rose over 22 for 24 hours or so a few days before the UK election.”

He explains: “The index, which is taken from a moving average of the S&P 500, is often referred to as the fear index – implying that right now the markets are very unafraid.”

Definition of risk

The world may appear to be in a remarkably stable period, with equity markets including the FTSE 100 and S&P 500 having made steady gains so far this year.

But volatility can be devastating to a portfolio which is exposed to too much downside risk.

A short-term bout of volatility in the markets may cause losses in a portfolio which is about to be drawn down by someone retiring, for example.

Andrew Harman, portfolio manager, multi-asset solutions at First State Investments explains: “The most common definition of risk in financial markets is the magnitude of short term fluctuations which is referred to as ‘market volatility’. This is only a one-dimensional view of risk. 

“We define ‘risk’ for the investor as the probability of not meeting their investment goals. The ultimate hazard to an investor is that they do not have enough income and/or growth to meet their current and future liabilities.”

Thomas Wells, fund manager for multi-assets CFA at Aviva Investors, suggests, from a client’s perspective, risk is losing money and not the volatility of returns.

“Despite this the finance industry is fixated with using volatility as a measure of risk to the extent that the terms volatility and risk are used interchangeably,” he notes.

“The majority of our investors perceive current market risk to be above average. This is hardly surprising given the busy political calendar in Europe and the uncertainties surrounding the current US presidency.”

But volatility levels at the moment are telling a different story entirely.

Figure 1: Rolling 3 year monthly volatility of the MSCI AC World index

The chart [see figure 1] shows volatility across global equities is currently at unusually low levels; in fact one of the lowest points in the last 10 years, he points out.