Volatility Targeting Model Portfolios

“I have not seen a market this volatile in my 66-year career”

John Clifton “Jack” Bogle – Founder of Vanguard Group

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Historically, The Market is More Volatile when it Drops

A volatility targeting approach uses dynamic asset allocation to achieve a stable level of volatility in all market environments by taking advantage of the negative relationship between volatility and return as well as the persistence of volatility. Volatility is negatively correlated with equity returns. As a result, a strategy which reduces volatility in periods when volatility is high and/or rising and which increases volatility in periods when volatility is low and/or falling is more likely to add value.

Take a look at this 15-year daily chart – the top window (black line) is the S&P 500 index. The lower window (red line) is the VIX, a measure of stock market volatility. Notice the inverse correlation between returns and risk.

The Volatility Targeting Portfolios We Offer

During the 16 years 2003-2018, the average S&P 500 index volatility was 18.2%. When volatility is low the portfolios will be allocated a larger % of US large cap stocks, when volatility is high, the % of stocks will be lowered. For the month of October 2008 the annualized stock market volatility was a whopping 89.8%. Last month, December 2018 annualized market volatility was 29.9%. In September 2017 volatility was a low 5.0%. For calendar year 2008 volatility was 41.3%, for 2017 year was 6.7%. As you can see, and as you know, stock market volatility is all over the place.

Our Volatility Target Portfolios will have targeted volatility significantly lower than the 18.2% average volatility.

Our 3 New Model Portfolios have target volatility of just 3%, 6% and 10%. That is, we expect to achieve an annual volatility that’s only 19%, 38% and 58% of the 18.2% stock market average.

Results of Backtest 2003 – 2019 3VT 6VT 10VT S&P 500 Index
Target Volatility 3% 6% 10%
Backtest Volatility 3.5% 7.0% 10.5% 18.2%
Maximum Drawdown -5.2% -10.5% -21.6% -55.2%
Compounded Annual Growth Rate (CAGR) 4.4% 6.8% 8.8% 9.3%
CAGR of Model as % of S&P 500 Index CAGR 47% 73% 95% 100%
Backtest Volatility vs. S&P500 Index 19% 38% 58% 100%
Risk Adjusted Return (Higher is Better) 126% 97% 84% 51%
Average Allocation to S&P 500 index ETF during the 16-year backtest 27% 52% 76% 100%
Minimum Allocation to S&P 500 index ETF during the 16-year backtest 3% 6% 10% 100%
Maximum Allocation to S&P 500 index ETF during the 16-year backtest 69% 100% 100% 100%

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