Investment markets never change. Until they do.

Human nature led many investors to believe the recent prolonged period of market calm would persist indefinitely – but that is why value investors do their best to take human nature out of the equation.


Andrew Evans

Andrew Evans

Fund Manager, Equity Value

The investment market turbulence seen in the first half of February will have left many portfolios battered and bruised and yet, whatever the short-term pain, most will have survived to fight another day.

One area where things have proved rather more final, however, is where people had been betting on market volatility itself – and specifically that the recent unusual and prolonged period of calm would persist almost indefinitely.

Here on The Value Perspective, we have regularly expressed doubts on this point – noting back in 2014, for example, the backward-looking nature of volatility can induce “a false sense of security”.

Last May, we wrote about “the calmest market in 20 years – and why that should make you nervous”.

Then, at the very end of 2017, we suggested the idea the current low volatility would persist seemed “increasingly improbable”.

None of which is to try and be wise after the event. We simply believe that you shouldn't extrapolate the future based on the present (a behavioural investment sin known as 'anchoring').  This is a fundamental reference point for all value investors (the art of buying stocks which trade at a significant discount to their intrinsic value).

Nor are we even claiming any specialist knowledge – as we will quickly prove by flagging up an article from a somewhat unlikely source: The London Review of Books.

In a piece called Short Cuts written at the end of January, financial author Donald MacKenzie discussed not only the ‘VIX’ Volatility Index – what he described as “Wall Street’s fear gauge” – but also the different exchange-traded funds (ETFs) that are linked to it and available to investors.

Betting against volatility in the market 

Some of these ETFs allow investors to bet markets will become more volatile but a handful – including an inverse of the VIX, known as the ‘XIV’ – essentially allow them to bet the other way.

Clearly, given the recent unusual and prolonged period of calm markets, that has worked out very nicely for investors in recent years but, equally clearly, it all went very, very wrong in the first week of February.

In his piece, McKenzie warns of the dangers of a “feedback loop” that stems from investors focusing too much on a simple economic idea, such as volatility, to the extent it becomes part of how they think and then affects how they act.

For those who cared to see, however, the warning signs were visible much earlier – spelled out in black and white in the XIV’s very own prospectus published back in 2010.

A warning from the XIV itself 

In the section entitled “What are some of the risks?”, the prospectus notes bluntly: “You are likely to lose part or all of your initial investment.”

And it continues, “in almost any potential scenario”, the investment’s value “is likely to be close to zero after 20 years and we do not intend or expect any investor to hold [it] from inception to maturity”.

That bleak possibility became all too real after the huge spike in market volatility seen on Monday 5 February proved sufficient to kill off both the XIV fund and the hopes of its many investors they would see anything but a small amount of their money back.

Maybe they were aware of the warnings in the prospectus, maybe not but, as we also noted in a piece last year, passive funds, like sausages, are only as good as their ingredients.


Andrew Evans

Andrew Evans

Fund Manager, Equity Value

I joined Schroders in 2015 as a member of the Value Investment team. Prior to joining Schroders I was responsible for the UK research process at Threadneedle. I began my investment career in 2001 at Dresdner Kleinwort as a Pan-European transport analyst. 

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