Take a step back and look at the market, and you’ll see that after notching a nice little gain it’s now down about 2% for the year.
And the same age-old question looms: What should I invest in? Or more to the point in your case: Where should I put my clients’ money?
Traditional asset allocation may or may not be dead, but one thing that seems fairly certain is that volatility is back. Indeed, even during the meltdown, when almost every asset class declined at once (and hence the reports of asset allocation’s demise), the one thing that was up was volatility.
So why not invest in volatility? It’s not an asset, obviously, but you can still invest in it thanks to a small handful of ETNs and ETFs. There are a few indexes that measure volatility (often called the “fear indexes”), but the most common is the VIX, which uses a range of S&P 500 index options. The other volatility indexes are VXN, which tracks the Nasdaq 100 and the VXD, which tracks the Dow Jones Industrial Average.
And to give an idea of the performance of the VIX, its price was $24.75 in mid-day trading on Friday, July 23, up from about $16 in early April. It was in the $11 to $12 range for much of 2005 and 2006, when we apparently had nothing to fear. (During the most fearful months in late 2009 and early 2010, it more than tripled to hit the low $70s).
And now, as Fed chief Ben Bernanke himself says that the prospects for economic growth are “unusually uncertain,” the concept of volatility is making its presence felt again.
Dirk van Dijk, senior Equity Strategist at Zacks.com, notes that the increase in mathematical trading has also increased the general level of volatility. And that even the growth of ETFs has helped the level of trading volume as it’s now so much easier to simply get in and out of entire sectors, as opposed to doing a careful, bottom-up analysis on a certain stock. He says that many investors use these types of buys as a way to hedge in their portfolios. That is, in the fearful markets, these investments are likely to do well.
A couple of the ETNs in this space come from Barclays. The iPath S&P 500 VIX Short-Term Futures ETN and the iPath S&P 500 VIX Mid-Term Futures ETN. “We have clients who use this in different ways within their portfolios,” says Tim Edwards, vice president of investor solutions at Barclays Capital. “ Some clients seek very short-term positions, and they use these funds based on where they think the VIX futures are going today.” Others use it more as a tool for diversification. “Volatility levels typically increase during times of equity market downturns. Some investors use our ETNs as a way to hedge against such events."