Real Returns by Dan Mikulskis

Q1 Are you saying vol control is a free lunch ?

A1 No, in any given year it can and has delivered a worse result than other investment approaches, and it cuts out some of the spectacular up years equities have. Over the long term we have shown it delivers better risk adjusted outcomes (for example here and here )

Q2 what about transaction costs

A2 vol control needs to be implemented on a liquid underlying with low spreads like FTSE futures. It is probably not practical to implement it on a single stock physical basis

Q3 Are there any investable vol control futures

A3 No, not yet – a common index would be a good starting point. Total Return Swap contracts with banks are possible, the attractiveness will depend on relative pricing.

Q4 does it employ excessive gearing and is this a problem

A4 no, the approach can reach exposure levels greater than 100% if volatility is very low and is usually implemented with a cap at 150%. In practice it will be implemented on a small portion of the overall investment assets and efficient management of collateral should ensure that >100% exposure is not a problem.

Q5 Is it an algorithm

A5 I would not call it an algorithm as that overstates the complexity of it and also implies that it is trying to outperform the market which it is not. It is simply an approach which allocates capital according to the amount of risk ( as measured by a relatively simple formula) being generated by an asset.

Q6 Does future performance depend on volatility increasing prior to a market crash ?

A6 the risk adjusted return benefits historically are related to the fact that more often than not, market volatility does increase prior to big market down moves. Exceptions to that were the 1987 crash and to a lesser extent the August 2011 move. In these situations vol control doesn’t offer much more protection than a fixed market allocation to equities. But the principle of allocating capital on a risk-weighted basis still holds whatever the relationship between volatility and the underlying.

Q7 could it be implemented in conjunction with the low volatility stocks approach

A7 Possibly, although given the trading costs of individual stocks our expectation is that it is unlikely to be cost effective