Volatility spike a surprise, but so were previous low levels
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VOLATILITY SPIKE A SURPRISE, BUT SO WERE PREVIOUS LOW LEVELS
As for many, last week's dramatic surge in volatility came as a surprise for Kevin Thozet, investment committee member at Carmignac. But he said the preceding quarters of low volatility were surprising too, leading to his team hedging a low-probability adverse market event.
The .VIX hit a more than four-year high of 65.73 points on August 5 after U.S. jobs data and the unwinding of the yen carry trade prompted a violent market sell-off. Having hit its third highest level after the COVID crisis and the GFC, the risk tolerance tracker has since moderated back to around 16.
"The magnitude of the surge in volatility indices did come as a surprise. But so too did the low level of those same volatility indices over the preceding quarters," Thozet said in written comments to Reuters.
"Such an environment led us to implement positions aimed at hedging an adverse market event with a low probability of occurrence using options on indices at a reasonable cost."
Last week's movements led Carmignac to monetize such positions, he said.
Thozet said while prolonged periods of low volatility tend to encourage investors towards greater risk taking and additional leverage, rising or high volatility leads to reduced leverage and lower risk taking.
"This is true for systematic strategies which start to sell when the VIX picks up, for market makers that tend to have a lower capacity to take risk, and for retail investors who are less inclined to buy equities when headlines are worrisome."
This can be problematic as herd behaviour means that periods of inordinate stability bring about periods of instability, he explained.
Short-term, Carmignac does not expect the market to fully recover to its July highs, amid U.S. recession risks, U.S. election uncertainty and the risk of further reductions in consumer spending.
(Lucy Raitano)
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