In early February, volatility, long absent, made a comeback, as global equity markets sold off and the VIX experienced its largest one day move ever, jumping 116% on the 5th. This was prompted in part by rising inflation fears that pushed bond yields higher around the globe. With output gaps–the differences between potential GDP and actual GDP–closing in both the U.S. and globally, a host of sentiment gauges hitting multi-year highs, and unemployment rates at multi-year lows, fears of inflation are certainly justified. Add in the valuation picture, which suggests that this may be the most broadly overvalued market in history, and you’ve got a recipe for investor angst.
So, where does that leave us? If history is any guide, we suspect that this injection of reality into what had been an unnaturally quiet market environment will spur activity in search of strategies that can provide true diversification. Given that investment grade debt, which has long played that role, has such a poor outlook on a real return basis, finding impactful diversifiers will be more difficult than in the past. In fact, short of costly market hedges, one of the only strategies that has historically exhibited low correlation to stocks, bonds, and commodities is managed futures, as you can see in the table below.
In the March issue of Investment Advisor magazine, I wrote more on the challenges of evaluating managed futures funds and given the lack of a standard benchmark, I provided some tips on how best to evaluate these funds.