If you’d like to read more about these ideas then why not check out my first blog which mentioned the ideas, from back in September 2012 here, or you can read more detail about how volatility control allows you to protect a portfolio against sharp falls, for a much reduced cost compared to a passive equity portfolio here.
Short video: Driving to the conditions, equity volatility and how to control it
Reading Time: < 1 minute
I would have expected the volatility balancing to have removed a lot more of the upside as well as the downside. Is this because over the period chosen (the last 25 years) and the maximum level of volatility chosen there was much more downwards than upwards volatility? Do you use VIX as your measure?
Nick, thanks for watching and leaving your comment! I’ll answer the easier of your questions first – the volatility measure in question is not the VIX, here we are using a backward looking volatility measure, similar to a 100-day historical measure but with an approach which gives a higher weight to more recent observations. As you are probably aware, the VIX, being based off the market price of options, is thought of as a forward-looking measure (albeit obviously influenced by what has happened recently). We investigated approaches that used the VIX, but found that they were not significantly superior on a risk-adjusted basis.
In regards to your other question, it is certainly true that in any given year you potentially give up a large amount of upside, for example in 2009 equity markets were up over 40% whereas this benchmark returned around 17%. On average over the whole period this benchmark was about 65% exposed to equities but as equity returns occur far from uniformly through time – and as you suggest, exhibit the characteristic that high volatility is more often than not associated with low or negative returns – the performance is very different to a strategy that would simply have a fixed 65% exposure.
Thanks again for your thoughts