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Economic Update

Recent volatility can’t be assessed in isolation

The dramatic share market correction experienced in February did not have a wide-ranging impact on face value, but investors must examine its flow-on effects to obtain a more accurate picture of how significant the fall in stock values really was, a portfolio manager has said.

Speaking at a recent media briefing in Sydney, Perennial Value Management portfolio manager Dan Bosscher said: “In many respects it’s important to think about what happened there, notwithstanding it was only a couple of billion dollars that were lost.

“It’s important to reflect on what happened there because the driver of that instrument, being volatility, also in part is a driver of many other instruments that have a lot more FUM (funds under management) in them than just a couple of billion dollars.”

Bosscher explained the products that would potentially experience a lag effect from the correction were those that have an implied short position on volatility, such as risk-parity offerings. He noted further significant market movements could eventuate as a result.

“When this volatility time series moves into the models of these products, as they do because these models run over a time series of data, that increased volatility may in fact cause some of these strategies to have to de-weight away from the risky asset, which could in fact exacerbate falls if markets are nervous at that period of time,” he said.

“So the VIX (volatility index) explosion at the beginning of February was really important for a very small amount of people and it was quite rightly discarded in terms of being of interest over the course of a few weeks.

“But it does require some reflection going forward because the volatility parameters have now been reset significantly from very low levels of volatility to more normal levels of volatility, which can in fact impact the modelling of some other products.”

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