Managing Volatility

Terry Flanagan

Today, volatility is everywhere in investment talk, but one hedge fund dives deeper into executing a managed volatility strategy.

Market participants today have resigned to living in the “new normal” of the equity markets—a rise in market risk, due to rampant volatility, and a reduction in returns.

TruColor Capital Management, a Boston based quantitative hedge fund, believes managing volatility can be executed through “Tactical Volatility Rotation,” strategy that uses innovative non-normal risk-prediction techniques to provide downside protection and upside participation in the return of asset classes.

The strategy aims to execute the general underlying principal of managing volatility—which is practicing risk management without sacrificing returns—a difficult feat given that volatility embedded in today’s markets ultimately may lower long-term returns.

“People talk about managed volatility, without understanding clearly what it is,” said Mike Dunn, chief research officer of TruColor. “Our version of (managing volatility) is achievable.”

Dunn told Markets Media that the firm’s Tactical Volatility Rotation looks for patterns in volatility to identify markets with high downside risk, and then rotates into lower volatility, such as cash. On long investments, the firm can use leverage.

“We look for patterns of volatility in a non symmetrical way, and treat downside risk. We can expect that distribution not be normal—it’ll be a bell curve,” said Dunn.

Volatility can be played, according to Dunn, and it should. Through the ‘new normal’ may be an expression coined to instill fear in the markets, in recent months, baseline volatility has risen on a fundamental level.

“Even before the crisis in 2008, volatility has been spiking up over the past four years,” Dunn said. “In the past, when a crisis would occur, VIX (Volatility Index) would jump up, and then it’d blow over and the VIX would come down to low levels—in the teens, and maybe even below ten.”

In today’s post crisis world, the aftermath of a macroeconomic event has left the VIX at a steady rate of 25—nearing 30 at yesterday’s close.
“It’s normal to have the VIX be higher than it was a decade ago, and the economy is just bumping along at zero…it doesn’t take much to push us back into a recession. This makes managing volatility all the more important.”

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