Taking a view on volatility

A central tenet of the Invesco Multi Asset investment philosophy is that true diversification comes from an unconstrained approach to asset allocation. This enables us to take a view on the volatility of different markets, and express that view through instruments that allow us to isolate volatility as a distinct asset type. We believe this is invaluable in terms of diversification.

How do we do this? We look for areas where we think that the relative risk implied by markets presents an opportunity. This can be expressed through paired investments in a single asset class—for example, we can express ideas that by design could benefit from an outperformance of Asian equity risk versus US equity risk, and, similarly, by an outperformance of the risk of the Australian dollar versus that of the US dollar. Or, we can look across asset classes. For example, we have ideas designed to capitalize on the relative volatility of UK equities and UK bonds. As with any idea in our portfolio, these volatility ideas are supported by specific macroeconomic themes and fundamentals – the first two ideas referenced above are tied to the China slowdown; the cross-asset UK idea is backed by the potential distortion created by Central Bank monetary policy.

Additionally, we can exploit the diversification qualities of volatility by embedding exposures within an equity-based investment idea. By adding long exposure to the volatility of various equity markets alongside allocations to equities, we believe we can at least partially offset the portfolio’s exposure to a significant equity market drawdown, without meaningfully jeopardizing our ability to capture the upside of a positively trending equity market environment.

It is important to note a few things about investing in volatility instruments:

  • While volatility may provide an additional diversification resource to investors, it is by no means a panacea — investors shouldn’t expect volatility instruments to completely replace other diversifying assets. Rather, they may be viewed as a complement due to their distinct qualities in a significant market selloff.
  • Additionally, volatility opportunities must be thoroughly evaluated, especially in markets where indiscriminate volatility sellers seeking income may overwhelm normal market dynamics.
  • Lastly, sometimes the best way to get attractive exposures to volatility may come from more sophisticated derivative markets that are not accessible directly by all market participants. Therefore, it is important to choose a manager with experience evaluating and trading in these markets.

We encourage investors to talk to their advisors about multi-asset strategies, and to do their homework into the experience of their fund managers. For Invesco Global Targeted Returns Fund, you can start here.

This article was written by Danielle Singer, a Senior Client Portfolio Manager for the Invesco Multi Asset team.