“Volatility,” says Ed Peters, partner and co-director of Global Macro at First Quadrant, “will be chronically low for awhile.” Yes, volatility responds to current events, such as the unfolding unrest in the Middle East, but it is broadly responsive to the business cycle, Peters notes, saying that we are in the part of the cycle that means low volatility.
From “2003 to 2006 there was low volatility,” Peters told AdvisorOne in New York on Feb 18. We had “high volatility from 2007 until mid-2010.” Now that volatility is low again, what does that mean for asset allocation? This topic came up because of a recent AdvisorOne Webinar, “Using Volatility as an Asset Class.” First Quadrant’s Director of Research, Paul Goldwhite, has written about this topic.
“We need strategies that build assets in rising markets and preserve them in declining markets,” advises Peters.
Peters uses “quantitative tools” tempered with qualitative factors to adjust First Quadrant’s investment strategies. “In low-volatility environments, you increase equities and reduce bonds to keep risk levels up; in high-volatility environments, you reduce equities to reduce risk levels,” he explains. The firm has $18 billion under management, “mostly for institutions,” and sub-advises mutual funds at Managers Investment Group.
Risk Parity—Balancing the Risk
For the past several years, Peters has been using a “risk parity strategy, balancing risks between stocks and bonds. It’s catching on now,” he says. For this strategy, he will “allocate according to risk, versus allocating according to capital.”