In recent years, some managers responded to low yields by selling covered calls to produce a stream of investment income for their clients, says Cott. After the prolonged bull market, advisors are also exploring options to generate returns from positions with a very low cost basis that would post a large capital gain if sold.
“They’re looking at this volatility as an opportunity to have discussions with their clients,” says Cott. “They’re asking whether there’s an opportunity to put a strategy on the table that could buffer a portfolio from downside risk. The collaring strategy seems to be more in discussion now, sort of in a hybrid role.”
Volatility has also led to more opportunities for event-driven investors running arbitrage strategies, says Loprete.
Rising volatility is, in part, a reversion to the norm for markets after an unusually long calm period, but it’s also a sign that the economic cycle, currently in a growth stage, is aging, says Jason Horowitz, investment director at Wellington Management and co-manager of the John Hancock Seaport Long/Short Fund (JSFBX).
Horowitz is part of the team managing the Seaport fund, a $746 million global macro strategy that incorporates a bottom-up fundamental stock-picking methodology. “On the long side, we’re trying to invest in companies with attractive fundamentals and valuations on an absolute and relative basis because, all other things being equal, we believe these companies are better suited to weather periods of volatility,” says Horowitz. “We also leverage Wellington’s broad and deep resources to contemplate macro, regional, sector, subsector and even factor risks and position the portfolios accordingly.”
Horowitz says people are using the Seaport fund in two ways—as a core equity allocation to complement a long-only position, and as a substitute for the entirety of a long-only position. The fund is managed to try to capture 80% of the market’s upside, 60% of its downside, with two-thirds of the volatility. As of June 29, JSFBX had three-year annualized returns of 3.7%.
Horowitz argues that quantitative easing has masked market instability—as the developed world moves toward monetary tightening, markets lose the façade of tranquility. “Political uncertainty is one of the factors that can drive volatility,” says Horowitz. “The most important indicator we’re focused on from a macro perspective is inflation and the interplay between potentially destabilizing forces like record high debt levels, low productivity growth, populist politics and the threat of protectionist trade policies.”
Escalating rhetoric stokes concern about a possible trade war. Thus far, tariffs on commodities like soybeans, materials like steel and products like industrial machinery have done little to slow the global economy, says Yardeni, but if Trump persists in implementing protectionist policies, it could lead to recession.
Brian Murphy, portfolio manager at Vivaldi Capital Management, a Chicago-based asset manager, sees international trade disputes as an opportunity to outperform by focusing on smaller, domestic equities. “Small-cap companies have had massive tailwinds compared to large-cap multinationals, so the net result is that you’ve had a number of companies down materially in 2018 while others have been up a lot,” says Murphy. “We haven’t seen that type of dispersion on a fundamental basis in a few years.”
The widening dispersion filters down into sectors, says Murphy, so a small company without much international exposure may outperform large-cap companies within the same sector. The 2017 tax reform package and Trump’s deregulatory policies are also increasing dispersion within industries and sectors.