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News headlines will impact market returns and volatility. Headlines often represents uncertainty and can increase the fear or probability of rare disasters.  More news headlines that generate investor uncertainty will lead to higher price volatility.  Headlines will change return expectations and cause investors to switch their views on the chance of markets being in a good or bad state. This will lead to greater deviations in prices. An increase in volatility will mean that return premium have to increase to compensate investors for the added risk from uncertainty. The short-term impact between risk and return can be complex, but longer-term links between news implied volatility and return is actually well-defined.  This link is especially the case when the news is focused on low probability potential disasters. There has been strong research work that when the probability of a rare disaster or left-hand tail event increases, returns will have to also increase to compensate for risk.

Volatility matters. Portfolio efficiency focuses on the return to risk trade-off. There has been a focus on low volatility strategies, but just as important is the idea that when volatility is high or increasing, investors should be walking away from risk. Adapting or adjusting to volatility is a dynamic concept. In simple terms, investors are often not compensated for shocks or increases in volatility. The low volatility argument is that investors are not compensated when volatility is high. Investors do not receive enough return compensation for either level of changes in volatility to keep their Sharpe ratios stable. Given this viewpoint, along comes a very interesting paper,  Volatility Managed Portfolios, by Alan Moreira ad Tyler Muir. The authors show that dynamic adjustment of portfolio exposures with respect to volatility will add to the portfolio's overall Sharpe ratio. If volatility is high, cut the risk exposure to that asset or factor.  This is contrary to traditional t

Asset price volatility follows a pattern of spiking only to then gradually decay. This is the essence of much of the GARCH modeling revolution. The patterns for volatility behavior is well-defined. The key issue is what causes the spikes in volatility. A simple answer is market uncertainty, but it is hard to determine what is uncertain versus what could just be a surprise. Surprises are unanticipated but may not be the same as uncertainty. Surprises will cause spikes in return, but they may not always lead to persistence in volatility.  Many volatility spikes are related to changes in liquidity as defined by money in the credit channel. A decline in money through increases in rates will cause reduction is risk-taking and change the discount factor used to price assets. This will lead to higher volatility which will decline as the market adapts to the change in liquidity conditions. Increases in liquidity will not generally lead to increases in volatility. Decreases in liquidity will le

Just like ‘eating right’ requires you to look through food labels to understand the nutrient content, ‘investing right’ means looking through asset class labels for the underlying factor risks. It's the nutrients in the food that matter. And similarly, the factors matter, not the asset labels. - Andrew Ang, Columbia University  The Ang quote has been making the rounds of financial blogs and news for some time. I like the analogy. Asset classes are like different foods. The real value of the food is in the nutrients. We eat the food to ultimately get at the nutrients.  Unfortunately, we often do not eat the nutrient directly. The foods and nutrients are balanced in the meals we eat. We like some foods. We have aversion to others. There are good meals prepared by skilled chefs and there are bad meals where we do not get any value. The difference is often with how the food is prepared. Asset management could be considered the cooking or the preparation of the meal.  Asset management

After attending a conference that highlighted some of the latest research on smart-beta and factor-based investing, I can say that this new focus is taking the industry by storm. There was no discussion about allocation to asset classes except in the context of benchmarks and the "old" approach. There is no questions that factor-based approach is a more nuanced view on risk allocation, but there is going to have to be more education on how this research can be implemented and what are the right factors.  One of the clear advantages of factor-based investing is that it can better target the unique (orthogonal) risks in the portfolio. Unfortunately, there is growing number of factors that are being discussed as potential risks. The market has moved well beyond a Fama-French three factor model approach, but how many risk factors are out there and how many are truly needed is very much up for debate. there is no set standard don what is a good factor and I believe the factor used

With equities moving higher and credit spreads tightening, hedge funds with equity beta exposure  showed strong returns. The exception was with the CTA and global macro indices which posted the largest declines. The best hedge fund strategies included market directional, fundamental growth, distressed, and emerging markets. It was a clear risk-on environment for the month. Nevertheless, most hedge fund strategies did not do well during the first quarter of the year. The only strong performer was the systematic CTA index which posted returns over 6%. The directional equity hedge funds have return differentials of over 12 percent relative to the CTA leader. The first quarter just provides more evidence that all hedge fund strategies are not alike. If there is more financial turmoil, the divergent strategies like managed futures will perform well. This strategies take advantage of market turmoil. Convergent strategies which focus on markets remaining well-behaved or those that have higher

The major theme for the second quarter will once again be focused on the Fed and rate increases. A market-dependent  Fed creates a feedback loop between market prices and Fed action. It seems the Fed is closely watching market behavior and will err on the side of caution if there is any sell-off or price disruption in markets. The market-dependent Fed has supported emerging markets and a risk-on equity environment. The markets have to read the thoughts of this dovish Fed and determine when the next rate increase based on any market feedback.  

What was the main cause for the negative performance with managed futures for March? The reversal in sentiment across bonds, rates and currencies is the easy answer. Bonds were selling-off in early March as a result of the strong equity rally. The switch from less risk to riskier assets dominated the movement in financial futures. However, the change in sentiment mid-month from the belief in a more dovish Fed caused bonds and rates to rally and reverse the bond outflows. After the bond rally from the earlier equity sell-off, traders shorted positions in March only to find themselves wrong-footed toward central bank sentiment. Long-only bond returns were flat but active traders were hurt by the intra-month gyrations. The dovish Fed sentiment carried over to currencies where trades based on the high rate differential in favor of the US were hurt. Currencies are expectational markets and the forward view is that central bank policies will converge not diverge. The dollar rally continues t

A key driver for holding managed futures is crisis beta, the low or negative correlation during times "bad times" versus traditional assets. The crisis beta is a direct result of the divergent strategy of long/short trend-following. If there is a market dislocation, the trend-following may short the assets that are doing poorly and increase long exposure to those assets that are doing well. This will dominate long-only investing that is not fully diversified.  Unfortunately, there are few guarantees of when trendS will occur and there is the potential for momentum crashes when trends reverse. Simply put, trend following will do well during bad times but there is a cost during normal times or period of trend reversals. You have to pay price for the benefit of trend-following.  One way of reducing the risk from trend-following is to diversify the strategies employed within managed futures. Instead of only using trend following, diversification can be achieved through investing

We have seen this story before. A reversal of negative fortunes for equities, a loss of momentum with global trends, and asset protection through monetary policy liquidity all lead to under-performance of managed futures. While managed futures has still be a highlight for hedge fund strategies in the first quarter of 2016, March was not kind to the strategy. The differential between managed futures and equities was close to 10%. The CTA index also underperformed relative to bonds and commodities. The first quarter still saw managed futures lead returns relative to equities, commodities, and diversified bods. Managed futures under-performed relative to the long bond which had good performance over the first two months of the quarter.  An ongoing issue for any strategy investor is determining when to invest. After the first two months of strong performance, the potential for a profit giveback from trend-followers was enhanced although there is little evidence to support an allocation tim

Nassim Taleb is a forward thinker who is always pushing scientists to think more deeply about of the statistical distributions of data. His latest effort has been trying to have more scientists accept the precautionary principle in their thinking about risks. Thinking of this principle places the focus on the risk of ruin. Investors are constantly facing risk as measured by the volatility associated with their assets positions and there is no shortage of good work on risk management. The really problem is whether the risks we face are actually measurable and whether not realizing this uncertainty may cause our ruin. Forget about the VaR in a portfolio. What matters is whether the risks of some unlikely or extreme event will cause permanent harm to the portfolio. VaR is a good indication of some measurable risks, but it is just a tool for what is  important in a thin-tailed or Gaussian world. The idea of the precautionary principle - that if an action is suspected of causing severe harm

Many money managers want to make the investment process complex as if complexity will have investors think there they should pay a premium for the services of the manager. In reality, simplicity is extremely valuable for any process faced with high uncertainty.  Simplicity starts with a philosophy that drives the discussion and decision-making. The Natixis Durable Portfolio Construction approach does a nice job of providing that good investment foundation. Of course, execution is the ultimate driver, but we think there is something to learn from the five tenents of their durable portfolio construction philosophy.No one will argue with their five tenets; nevertheless, explicitly stating them forces decisions to pass through their filter. First, put risk ahead of other considerations. Ultimately, money management is about principle protection because the cost of coming out of any drawdown is high. Putting risk first does not mean that returns should be scarified. Rather, the focus should