5.1 Volatility Investing
Questions and Answers 5.1 (with Peter van Kleef, Lakeview Capital Market Services)
Q. Why aren't even the best volatility fund managers immune to losses?
A. No one is immune to occasional losses. The assumption I am making in such a case is that we are referring to losses that are not major when compared with the assets being managed. Of significance would be whether such losses arise from a well-diversified statistical arbitrage or relative value strategy or from an unbalanced concentrated bet. In the case of the former, some trades are expected to lose and some are expected to gain, with the majority gaining, assuming always equal bet sizes. Then, the occasional losses are just part of the expected payoff distribution. In case of the latter, however, losses are often the result of ‘bad luck’ and suggest that the strategy being followed is one that is based on luck as opposed to skill. This is cause for concern. Hence it is important to determine and understand what caused the drawdown rather than fret over the fact that it occurred. The good thing about volatility is that keeping relative prices at unreasonable levels is very expensive. Mean reversion for closely related products therefore tends to be exceptionally reliable.
Q. What makes it so difficult to avoid losses?
A. Most volatility fund managers bet directionally, even though they claim otherwise. Most also tend to bet with insufficient diversification and on absolute ...