From the January 2010 issue of Research Magazine • Subscribe!

Seeking Answers from VIX

What is the VIX telling us right now?

The VIX indicator has become a popular gauge of investor fear and complacency. Using a weighted blend of various S&P index options, the VIX attempts to estimate the implied volatility for the S&P 500 over the next 30 days.

What is the VIX telling us right now?

During late 2009, the VIX index traded around 24, which isn't far away from its 52-week low of 20.10. This likely indicates that investors have become over-optimistic about future stock prices. A low VIX could also be interpreted as a sign that investors aren't fearful about a huge swing in stock prices. Conversely, an elevated VIX, as we saw last year, could be viewed as a sign that investors are overly pessimistic.

The VIX concept was first introduced in a research paper by Professor Robert E. Whaley at Duke University.

The fact that riskier assets have handedly outperformed lower risk assets since the market's lows in March 2009 is quite telling. It indicates an increased appetite for risk-taking by the crowd.

For industry sectors, volatile technology stocks (XLK) have led most S&P 500 sectors in performance. Within the global equity market, risky emerging market stocks (EEM) have outperformed stocks from developed countries (EFA). In the bond market, high-risk junk debt (HYG) yields and performance have outpaced the investment-grade bond market (AGG). Instead of being a cause for celebration, shouldn't increased risk taking should be a cause for reflection?

Entrusting your clients' money to investment managers is no guarantee of success and sometimes results in full-blown disaster.

In 2008, the Oppenheimer Core Bond A (OPIGX) cratered 35.83 percent yet the Barclays Aggregate Bond Index as tracked by Vanguard's Total Bond Market ETF (BND) climbed 5.17 percent. How long will it take Oppenheimer's bond fund shareholders to make up that 41 percent deficit?

A recent study by Morningstar found that active management, when adjusted for risk, has lagged key market indexes over the past three years. According to the company, 63 percent of active mutual funds underperformed when adjusted for risk, size and style.

While most portfolio managers would dismiss any three-year period as being meaningful, think again. Because this particular three-year study encompasses both a bull market (2007) and a subsequent bear market (2008), it reveals just how badly active funds have fared during both market conditions.

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