Volatility was back this past week and along with it, the usual litany of finger pointing and sideways glances, trying to figure out who or what caused the selloffs. While there are many hot-takes and quick reads, some of the best writing on volatility comes in long-form. A great place to start is Volatility and the Alchemy of Risk (https://static1.squarespace.com/static/5581f17ee4b01f59c2b1513a/t/59ea16dbbe42d6ff1cae589f/1508513505640/Artemis_Volatility+and+the+Alchemy+of+Risk_2017.pdf), a long form piece from 2017 written by Chris Cole of Artemis Capital. Eminently quotable, Cole details the reinforcing cycles that have become a large part of markets and the dynamics that can either perpetuate or shatter these cycles. Volatility, correlation and risk are well covered in this insightful piece, which was prescient in its’s warning that, should volatility increase dramatically:
[I]nverse-VIX products will experience an “unwind event” resulting in major losses for scores of retail investor [sic]… The products are a class-action lawsuit waiting to happen.
Given the recent VIX spike and death of the inverse volatility ETF XIV (https://www.barrons.com/articles/a-violent-unwinding-volatility-spikes-kills-one-etn-1517931789), it’s not surprising that Cole and Artemis received some negative attention (https://www.theguardian.com/business/2018/feb/09/how-artemis-hit-bulls-eye-by-betting-on-stock-market-collapse) during the recent volatility and were forced to respond in their own defense (https://static1.squarespace.com/static/5581f17ee4b01f59c2b1513a/t/5a82f5b8419202b94d25fd61/1518532025573/Response+to+Guardian+Article.pdf).
Risk Parity
In addition to long volatility funds like Artemis, risk parity has come under fire this week. In response, Michael Mendelson from AQR wrote the bluntly titled “Not Risk Parity Funds” (https://www.aqr.com/library/aqr-posts/not-risk-parity-funds) in which he details how, while risk parity and trend-following strategies sell in response to rising volatility, the timing and magnitude of the recent selling doesn’t implicate risk parity:
Instead, we are inclined to blame those fickle humans who actually sometimes just change their mind about the right price to pay for stocks and, in the words of a famous fund manager, become the real hammer on the downside”
Risk Parity heavy-hitter Salient also weighed in on the allegations, with Ben Hunt sending a note to subscribers first agreeing with Mendelsons response, and further noting:
[W]e published a piece last week on Epsilon Theory that captures what we DO think is responsible for what’s going on in February (and the months ahead), titled “The Fundamentals Are Sound” (http://www.epsilontheory.com/the-fundamentals-are-sound/).
Epsilon Theory is always worth a read, and readers who have been following us will see overlap with themes we’ve discussed before. To request a trial….
