Volatility is cheap these days. That may sound strange at first. But, the Invesco Multi Asset team views volatility as an investable asset type that can be included in our investment strategy. Why might this make sense? We believe volatility can provide additional diversification and return benefits when combined with our portfolio’s other asset exposures. For example, when volatility is low, markets may benefit. But when it rises, markets can come under pressure.
Volatility on sale
Over the past several years, central banks have been heavily involved in markets, which tended to drive asset prices up and volatility down. But we believe volatility is likely to rise from here. Today, global financial markets no longer have the support of the US Federal Reserve’s bond buying stimulus program, known as quantitative easing (QE), and remain uncertain as to when interest rates will rise. Expectations for equity and bond market returns going forward are also less sanguine.
Price check on Asia
We see rising volatility as an opportunity – and an attractive one, at that. On a valuation basis, we believe it’s currently a fairly cheap investment, especially in Asia. Over the longer term, Asian equity markets have been more volatile than those of the US. Yet, we believe current estimates of future volatility levels do not reflect this longer-term relationship. At the same time, the region’s fundamentals are telling us that higher volatility is likely to be realized over time.
To put this theme to work in our portfolio, we made investments in volatility instruments on the Hang Seng and Hang Seng China Enterprise indexes, seeking to take advantage of differences in implied and realized volatility over time. Implied volatility is a forward-looking estimate of an index’s price movement, whereas realized volatility is a backward-looking measure of an index’s actual past volatility. At the same time, we sold a volatility investment on the S&P 500 Index.
If our view on the direction of volatility in Asia versus the US is correct, the portfolio will be paid the difference between the Hang Seng indexes’ realized volatility and the S&P 500 Index’s realized volatility. In other words, the portfolio has the potential to gain from our view that the difference between volatility in the two regions will rise over time.
An unconstrained approach
A central tenet of our investment philosophy is that true diversification comes from an unconstrained approach to asset allocation. When it comes to traditional asset allocation approaches mixing equities, bonds, and other asset types, volatility typically represents how much risk will be embedded in the portfolio.
However, taking a view on the volatility of different asset types, and expressing that view through volatility instruments, means that volatility can be viewed as an asset type in its own right. We believe this is invaluable in terms of diversification and generating distinct return streams.
To learn about our team’s strategy, visit our page for Invesco Global Targeted Returns Fund.
Important information
Volatility measures the amount of fluctuation in the price of a security or portfolio.
Volatility instruments are financial instruments that track the value of implied volatility of other derivative securities.
The Hang Seng Index is an unmanaged index considered representative of the Hong Kong stock market and includes the largest companies traded on the Hong Kong Exchange.
The Hang Seng China Enterprise Index in an unmanaged index tracking the performance of mainland China companies listed on the Hong Kong Exchange (known as H-shares).
The S&P 500® Index is an unmanaged index considered representative of the US stock market.
Diversification does not guarantee a profit or eliminate the risk of loss.
The risks of investing in securities of foreign issuers can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.
In general, stock values fluctuate, sometimes widely, in response to activities specific to the company as well as general market, economic and political conditions.
The information provided is for educational purposes only and does not constitute a recommendation of the suitability of any investment strategy for a particular investor. Invesco does not provide tax advice. The tax information contained herein is general and is not exhaustive by nature. Federal and state tax laws are complex and constantly changing. Investors should always consult their own legal or tax professional for information concerning their individual situation. The opinions expressed are those of the authors, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.
Before investing, investors should carefully read the prospectus and/or summary prospectus and carefully consider the investment objectives, risks, charges and expenses. For this and more complete information about the fund(s), investors should ask their advisors for a prospectus/summary prospectus or visit invesco.com/fundprospectus.
All data provided by Invesco unless otherwise noted.
Invesco Distributors, Inc. is the US distributor for Invesco Ltd.’s retail products and collective trust funds. Invesco Advisers, Inc. and other affiliated investment advisers mentioned provide investment advisory services and do not sell securities. Invesco Unit Investment Trusts are distributed by the sponsor, Invesco Capital Markets, Inc., and broker-dealers including Invesco Distributors, Inc. PowerShares® is a registered trademark of Invesco PowerShares Capital Management LLC (Invesco PowerShares). Each entity is an indirect, wholly owned subsidiary of Invesco Ltd.
©2015 Invesco Ltd. All rights reserved.
