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If The Tide Turns: Finding Outperformance If There Is A Return To Volatility

August saw investors in Europe’s Developed Markets return to riskier assets following the sell-off early in the month. Indicators of implied future volatility accelerated and hit recent highs during the week of August 8th. This came amid growing concerns around broad geopolitical tension. However, the equity market response was more complex than just a broad sell-off.  

Source: S&P Capital IQ, 9 August 2014

We track the performance of 8 style indicators, representative of common equity strategies.  This helps to provide insight into what types of companies are outperforming or underperforming in different markets.  The chart below shows the cumulative return spread of going long the top 20% and short the bottom 20% of the given index for each style.  Looking at the performance in the S&P BMI Europe Developed Markets in August we can see the early underperformance of equities was concentrated in companies with high realised volatility and beta (Volatility Indicator).  At the same time, investors moved into companies with strong operating performance (Capital Efficiency Indicator).  However, since that week, the concerns over volatility have diminished.   High volatility and momentum stocks have thrived while other styles finished the month relatively flat.

Source: S&P Capital IQ Alpha Factor Library, as of 8th September 2014

Backtested returns do not represent the results of actual trading and were constructed with the benefit of hindsight. Returns do not include payment of any sales charges or fees. Inclusion of fees and expenses would lower performance.  Past performance is not a guarantee of future results.

We looked at the performance of these styles historically in increasing/decreasing VSTOXX regimes since 2000.  The regime analysis is consistent with the performance in August.  While the VSTOXX retreated in August, it remains at historically low levels compared to the historical average since 2000 (approximately 15 currently versus 25 historically).  Capital Efficiency and Earnings Quality strategies have performed well in increasing volatility environments.  Price Momentum has been a strong performer in both regimes.  It is important to understand these themes if the tides begin to turn on the current low volatility regime.

Source: S&P Capital IQ Alpha Factor Library, as of 8th September 2014 

Regime defined as Increasing/Decreasing VSTOXX in months where VSTOXX is greater than/less than or equal to trailing 3 month average. For illustrative purposes only. Returns do not include payment of any sales charges or fees. Inclusion of fees and expenses would lower performance.  Past performance is not a guarantee of future results.

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