Prepare to be vexed by the VIX.
After global markets dropped then dramatically rebounded at the end of June, volatility, often measured by the CBOE Volatility Index, or VIX, will be of central concern to investors throughout the rest of the year, according to a recent report by New York-based BlackRock.
But markets aren’t pricing in the volatility risk, according to Heidi Richardson, head of investment strategy at BlackRock’s U.S. iShares.
“Volatility spikes whenever there’s bad news in the system,” Richardson says. “Looking at the Brexit vote, the attempted coup in Turkey, ongoing issues with Italian banks and the upcoming U.S. election, there’s more volatility on the horizon, and it can be really corrosive to client portfolios.”
In the BlackRock Investment Institute’s “Mid-Year 2016 Global Investment Outlook,” the asset manager wrote that lower equity returns, extraordinary monetary policy and macro-level uncertainty increase the risk of volatility.
BlackRock identified political uncertainty related to the United Kingdom’s vote to leave the European Union last month and the rise of populism in the U.S. and elsewhere as a direct challenge to “trade, economic growth and markets.”
“When we talk to clients, their response falls into discussions of three buckets,” says Richardson. “Either they want to go completely risk-off and invest in things with low correlation, or they want some equity exposure but they want to do it with volatility in mind because they’re aging or they’re long-term investors who embrace the volatility.
“There’s no solution for everyone. The most significant theme is that we should be structuring portfolios with the potential volatility in mind.”
Any strategy to ride out volatility should begin with diversification across asset classes, says Richardson, but the low-return environment should also be kept in mind.
She says that advisors and investors may want to seek strategic sources of income, like dividend-paying equities, to ride out the instability.