In an earlier post we talked about the short volatility (VIX) products that had added to the recent global equity market volatility.

 

The experience of these products prompted a good article from Barry Ritholtz, Five Rules to Help Avoid Investing Disaster.

The Inverse Volatility Products will enter history along-side CDO’s. It is likely that 95% of the wealth invested in these Products will be wiped out when they are finally wound up/terminated.  Well worth following developments here.

 

I am somewhat bewildered from an investment strategy perspective why these exposures would end up in Portfolios at this time. It is a prime example of chasing historical returns. It is always a good idea to be guided by value.  The cost of buying volatility protection was very low. Therefore there was no value shorting market volatility, as these Products did. It is also a good idea to have a counter-cyclical bias in your investment approach: when markets are at historical extremes, i.e. historically low volatility, it is a good idea to reduce the exposure to that market extreme. Markets revert from extremes toward averages – often violently as we have recently witnessed.

This is basis of portfolio risk management and consistent with focusing on managing risk rather than trying to time markets and chase historical returns. I think most of the funds management industry was working out how to go long volatility given the over-brought nature of the global equity markets in January, not short it!  Some form of market correction was widely anticipated, the timing was just unknown.

 

Anyway, ………… the rules outlined to avoid making investment mistakes:

1. Avoid new products – if they are a good investment no need to hurry – e.g. the Buffet rule in relations to Initial Public Offerings (IPOs)
2. Learn from history – markets are volatile never get complacent – Hubris before the fall
3. Never buy anything you don’t understand – another Buffet rule
4. I would say get good investment advice i.e. wholesale products vs retail product comments, in fact considerable value can be added to client portfolios in this area and costs reduced by accessing appropriate investment strategies not readily available
5. Greater returns always comes with greater risk – this is a fundamental axiom of investing, never forget it.  If it is too good to be true, it probably is.  There are never “easy” sustainable returns in investing.

 

Happy investing.

 

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