Where Volati lity Fits Super funds which have a traditional growth-oriented asset allocation strategy would most likely place the allocation in the alternative space under ‘hedge funds’. Some of the larger funds and institutions would treat the exposure as part of the asset class in which the volatility strategy is applied, ie. an international equity volatility strategy would be included as part of the international equities allocation. There is a smaller number of funds which have an “other” space in their asset allocation strategies where they quarantine non-traditional and new investments and some funds would place volatility investing in that space.

Those funds which employ alpha and beta strategies might allocate volatility to either of those strategies depending upon their requirements and how those portfolios are structured. There is also an argument for considering volatility investing within a risk management framework and one of Australia’s large institutional investors is currently considering volatility investing from that perspective. For superannuation funds which still have a defined benefit component, an allocation to volatility with its consistent return profile can be used to underpin the funding obligations of the sponsoring employer/s. Given the potential alpha-generating characteristics of volatility, an allocation of between 2 and 5 per cent is generally regarded as appropriate.

The degree of risk associated with volatility investing is certainly no more than hedge fund investing and depending upon the strategy selected, may be somewhat less risky. For example, if a volatility strategy using only exchangetraded index derivatives was employed, there would be less risk than using a strategy which traded over the counter options because counterparty risk would be eliminated. Fad, Future Asset Class?

There is sufficient evidence available to show that there is always volatility in the markets at sufficient levels to enable skilled fund managers to reap consistent returns – even in low volatility periods, because investors will always over and undershoot in their expectations and pay too much or too little for assets. Many in the industry have experimented with highly diversified portfolios in the mistaken belief that the greater the degree of diversification, the greater the chance that these portfolios will be able to withstand a severe market meltdown. What has persisted however, are heightened levels of volatility and continued opportunities to capitalise on this market phenomenon.