1

For illustrative purposes only – does not constitute investment advice.

Frank Brosens

Has Volatility Reached a Permanently Low Plateau?

The views expressed in this commentary are solely those of the presenter as of the date of this commentary. The views expressed in this commentary are subject to change without notice. This commentary is provided to you for informational purposes only and does not and is not intended to constitute investment advice, nor does it constitute an offer to sell or a solicitation of an offer to buy any security or investment product.

HOW DOES PORTFOLIO INSURANCE WORK?

$PnL of Synthetic Put Replication$100 Portfolio, 2yr 10% OTM Put, Initial Hedge -$30

Adjust futures position for every 1% move in the portfolio

($30)

($20)

($10)

$0

$10

$20

$30

$70 $80 $90 $100 $110 $120 $130

UnderlyingMarketPortfolioValue

ReplicatedPutPnL

UninsuredPortfolioPnL

InsuredPortfolioPnL(Port.+Put)

Cuml.Buy/SellforPutReplication

VALUATIONS THEN AND NOW

0

2

4

6

8

10

12

14

16

18

0

5

10

15

20

25

30

35

40

45

50

1880 1900 1920 1940 1960 1980 2000 2020

Long-TermInterestRates

Price-EarningsRatio(C

APE,P/E10)

USCyclicallyAdjustedPrice/EarningsRatio

Price-Earnings Ratio

Long-TermInterestRates

20001981

1929

1921

30.73

1966

1987

0%

20%

40%

60%

80%

100%

120%

140%

160%

0%

20%

40%

60%

80%

100%

120%

140%

160%

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

2012

2014

2016

USMarketCapitalizationtoGDP

1987

Source: Online Data by Robert Shillerhttp://www.econ.yale.edu/~shiller/data.htm

WHAT HAPPENED DURING THE 1987 CRASH?

Source: A Brief History of the 1987 Stock Market Crash with a Discussion of the Federal Reserve Response (Carlson, 2013)

Source: A Brief History of the 1987 Stock Market Crash with a Discussion of the Federal Reserve Response (Carlson, 2013)

Source: Report of the Presidential Task Force on Market Mechanisms (Brady Report, 1988)

220

240

260

280

300

320

340

220

240

260

280

300

320

340S&P500IndexDaily1987

Strategies Similar to Portfolio Insurance TodayVolatility Targeting

y=-0.4872x+0.0025R²=0.1137

-30%

-20%

-10%

0%

10%

20%

30%

-20% -15% -10% -5% 0% 5% 10% 15% 20%

1Mon

thCha

ngeinRealized

Volatility

1MonthSPXReturn

SPXReturnsvs.RealizedVolatility

y=1.1029x- 0.0038R²=0.0731

-1.00

-0.80

-0.60

-0.40

-0.20

0.00

0.20

0.40

0.60

0.80

1.00

-20% -15% -10% -5% 0% 5% 10% 15% 20%

Chan

geinLeverageRa

tio

1MonthSPXReturn

SPXReturnsvs.ChangeinLeverageRatio

-

0.20

0.40

0.60

0.80

1.00

1.20

1.40

5/4/19

765/4/19

775/4/19

785/4/19

795/4/19

805/4/19

815/4/19

825/4/19

835/4/19

845/4/19

855/4/19

865/4/19

875/4/1988

5/4/19

895/4/19

905/4/19

915/4/19

925/4/19

935/4/19

945/4/19

955/4/19

965/4/1997

5/4/19

985/4/19

995/4/20

005/4/20

015/4/20

025/4/20

035/4/20

045/4/20

055/4/20

065/4/20

075/4/20

085/4/20

095/4/20

105/4/20

115/4/20

125/4/20

135/4/20

145/4/20

155/4/20

165/4/20

17

Vol.TargetingLeverageRatio(SPX,12%Target,1.25Cap)

RealizedVol.

Tendency for Leverage to Decrease as Market Drops & Volatility Rises

* 1-2 month half-life used for realized volatility

Strategies Similar to Portfolio Insurance TodayRisk Parity

0%

10%

20%

30%

40%

50%

60%

10/19/19

78

10/19/19

80

10/19/19

82

10/19/19

84

10/19/19

86

10/19/19

88

10/19/19

90

10/19/19

92

10/19/19

94

10/19/19

96

10/19/19

98

10/19/20

00

10/19/20

02

10/19/20

04

10/19/20

06

10/19/20

08

10/19/20

10

10/19/20

12

10/19/20

14

10/19/20

16

RealizedVol

US10yrVol

SPXVol

ComdtyVol

(1.00)(0.80)(0.60)(0.40)(0.20)

-0.200.400.600.801.00

10/19/19

78

10/19/19

80

10/19/19

82

10/19/19

84

10/19/19

86

10/19/19

88

10/19/19

90

10/19/19

92

10/19/19

94

10/19/19

96

10/19/19

98

10/19/20

00

10/19/20

02

10/19/20

04

10/19/20

06

10/19/20

08

10/19/20

10

10/19/20

12

10/19/20

14

10/19/20

16

RealizedCorrelation

Stock/Comdty

Bond/Comdty

Stock/Bond

0.00

0.20

0.40

0.60

0.80

1.00

1.20

1.40

1.60

10/19/19

78

10/19/19

80

10/19/19

82

10/19/19

84

10/19/19

86

10/19/19

88

10/19/19

90

10/19/19

92

10/19/19

94

10/19/19

96

10/19/19

98

10/19/20

00

10/19/20

02

10/19/20

04

10/19/20

06

10/19/20

08

10/19/20

10

10/19/20

12

10/19/20

14

10/19/20

16

$MV/AUM(AssetClassLeverage)

US10yr

SPX

Comdty

(0.20)-0.200.400.600.801.001.201.401.601.800.00

0.50

1.00

1.50

2.00

2.50

10/19/19

78

10/19/19

80

10/19/19

82

10/19/19

84

10/19/19

86

10/19/19

88

10/19/19

90

10/19/19

92

10/19/19

94

10/19/19

96

10/19/19

98

10/19/20

00

10/19/20

02

10/19/20

04

10/19/20

06

10/19/20

08

10/19/20

10

10/19/20

12

10/19/20

14

10/19/20

16

SumofV

ols+

Correlatio

ns

TotalLeverage

RuleofThumb:SumofVolatilitiesandCorrelationsvs.TotalLeverage

TotalLeverage(leftaxis) Vols+Corrs(rightaxisinverted)

Tendency for Leverage to Decrease as Market Drops & Vols (and Possibly Correlations) Rise

* 1 year lookback used for volatility & correlation statistics

Strategies Similar to Portfolio Insurance TodayTrend Following CTAs

Equity Exposure Decreases and Eventually Goes from Long to Short as Market Drops

-2.00

-1.00

0.00

1.00

2.00

3.00

4.00

3/9/19

783/9/19

793/9/19

803/9/19

813/9/19

823/9/19

833/9/19

843/9/19

853/9/19

863/9/19

873/9/19

883/9/19

893/9/19

903/9/19

913/9/19

923/9/19

933/9/19

943/9/19

953/9/19

963/9/19

973/9/19

983/9/19

993/9/20

003/9/20

013/9/20

023/9/20

033/9/20

043/9/20

053/9/20

063/9/20

073/9/20

083/9/20

093/9/20

103/9/20

113/9/20

123/9/20

133/9/20

143/9/20

153/9/20

163/9/20

17

LeverageRatioofSPXAllocationinCTAModel

LeverageRatioofSPXAllocation

3m.Avg.

LogSPXIndex

y=8.8671x- 0.0798R²=0.4775

-2.5

-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

-25% -20% -15% -10% -5% 0% 5% 10% 15%

Chan

geinLeverageRa

tioofS

PXAllo

catio

n

1MonthSPXReturn

SPXReturnsvs.ChangeinLeverageRatioofSPXAllocation

* 1-4 month momentum signal, risk adjusted by recent volatility

Strategies Similar to Portfolio Insurance TodayDaily Levered Equity Index and VIX ETFs

$-

$500

$1,000

$1,500

$2,000

$2,500

$3,000

$3,500

$4,000

8/30/2010 8/30/2011 8/30/2012 8/30/2013 8/30/2014 8/30/2015 8/30/2016 8/30/2017

$Millions

$MillionsofSPXBetaEquivalentstoSellfor-1%SPXMove

Top10LeveredUSEquiyIndexETFs

Top5LeveredVIXETFs

*Increase inVIXduetostronginflowsintoshortETFsand SPXbetaincreasefromVIXdecrease

$100AUMExampleFundType IndexLevel AUM NetAssetsOwned IndexLevel NetAssetsOwned $PnL AUM $Trade NetAssetsOwned2xLongFund 100 $100 $200 95 $190 ($10) $90 ($10) $1801xShortFund 100 $100 ($100) 95 ($95) $5 $105 ($10) ($105)For2xlongand1xshort,fundsneedtobuy/sell2xpercentofAUMforeverypercentmoveinIndextoachieveAssets=Leverage(-1forshort)xAUMatclose

EndofPreviousDay EndDayBeforeRebalance RebalanceatClose

Strategies Similar to Portfolio Insurance TodayDealer Option Positioning

Illustration Based on Covered Call Fund Positioning & Hypothetical Dealer Put Positioning

ESTIMATED COMBINED SELLING IN MARKET DROP

HAS VOLATILITY REACHED A PERMANENTLY LOW PLATEAU?