One year later, vol control funds continue to draw focus in severe selloffs
One year ago today, on August 24, 2015, severe volatility drove S&P 500 futures to
be halted in pre-market trading, listed SPX option markets to go black, and other
equity market dislocations to arise. That moment was one of the most severe
shifts in SPX volatility, switching from a relatively low volatility period to extremely
high volatility (11% selloff in a week) almost instantaneously. Vol control funds,
multi-asset investment portfolios with a dynamic asset allocation determined by
market volatility, were important contributors to the severity of that selloff. In
this piece, we provide background on vol control funds and guidance on how
investors can monitor them going forward.
Vol up, sell stocks: a market feedback loop
Vol control products sell equities when volatility is rising and buy equities when
volatility is falling, creating a market feedback loop. Product growth has slowed -
but rebalancing impact has grown in illiquid, risk-averse markets. This has been,
and continues to be a driver, of the repeated pattern of sharp selloffs followed by
consistent rebounds seen in the last 2Y, and contributes to high skew and vol-ofvol
in derivative markets. Several fund features - most importantly lags in trading
following a volatility spike - keep the products from becoming a systemic risk.
Sharp transitions from low vol to high vol are becoming increasingly common
The most important trading implication of a large vol control market is the funds'
impact on sharp selloffs. We have had almost as many transitions from very low
vol to much higher vol in the last 6Y as we have had in the prior two decades.
DB Vol Control Composite tracks current positioning
Through fund-by-fund research of $200bln of vol control funds, we have
categorized the funds into four categories, and created a DB Vol Control
Composite model based on systematic strategies that we believe captures the
essence of these products' equity allocation patterns. We estimate that a sudden
4% global equity selloff today would drive $20bln of selling by vol control funds -
less than earlier this year - as realized vol is now below many funds' thresholds.
Last August, around $50bln of equities were sold by vol control funds
We estimate that in the aftermath of the Aug-15 selloff, vol control funds sold
around $50bln of global equities, and in the aftermath of the Brexit vote sold
around $25bln. These numbers are large in absolute terms - and stand out
when they're coming from an investment type that does minimal asset allocation
rebalancing on a typical day-to-day basis.