Seeking Asymmetric Returns
Improving the Odds of Investment Success
July 26, 2011
“The essence of investment management,” said legendary investor Benjamin Graham, “is the management of risks, not the management of returns.” Indeed, recent market events—and the accompanying spikes in volatility across a multitude of asset classes (Display) serve as a reminder that as well as an investment process for the upside, a strategy to protect investors’ capital from downside risk, too, is of critical importance.
We believe that recent market volatility highlights the importance of seeking “asymmetric returns”—investment strategies that maximize upside potential while capping downside risks. Asymmetric return profiles have traditionally been difficult to attain for the long-only, buy-and-hold investor. But for those open to a multi-asset, global opportunity set and the use of derivatives, a variety of effective strategies are available.
These strategies exploit a variety of market anomalies. Such anomalies exist because markets are not always efficient and liquid, investors do not always behave rationally, and thanks to the varying preferences and constraints faced by different groups of investors, asset prices can depart significantly from fundamentals. Our research suggests that the key to such strategies—and to achieving sustainable positive returns over time—is a dynamic risk-management process that limits the probability of large portfolio losses.
Volatility Is Highly Correlated
Through March 31, 2011
Historical analysis is not a guarantee of future results.
Equities’ volatilities are represented by the CBOE Volatility Index (VIX), Australian dollar volatility by one-month implied volatility on AUD/USD, and debt volatilities by option-adjusted spreads on the Barclays Capital US Corporate Index and Barclays Capital Emerging-Market Bond Index.
Source: Bank of America Merrill Lynch, Barclays Capital, Bloomberg and Chicago Board Options Exchange