Volatility Targeting Investment Strategies Unlikely to Continue Delivering Higher Returns, According to BNY Mellon

NEW YORK, July 31, 2012 /PRNewswire/ -- Investors should be cautious about the continued success of volatility targeting investment strategies, despite historical data that show  such strategies would have added value in recent years, according to a white paper from the BNY Mellon Investment Strategy & Solutions Group (ISSG).

Many investment strategies increase allocations to stocks during periods of low volatility and sell stocks when volatility is high.

The report, Volatility Targeting May Miss the Mark, notes that such volatility targeting strategies would have worked well over the last 20 years, but would have been far less successful over a longer time frame, such as the last 60 years. 

"Considering only the recent period can make volatility targeting appear to be an attractive strategy, but investors are unlikely to find the strategies so rewarding in the future," said Ralph Goldsticker, senior investment strategist for ISSG and the author of the white paper.  "Rather than mechanically trading based on the level of volatility, investors would be better off evaluating market fundamentals, both risk and return."

Goldsticker said ISSG has been studying the behavior of volatility targeting investment strategies as the introduction and adoption of such strategies have gained momentum over recent years.

The ISSG report notes that the last 20 years were unusual, as stocks delivered high returns with low volatility during the 1990s.  This was followed by a decade of low returns and high volatility, the report said.  A volatility targeting strategy would have called for an above-average allocation to stocks during the 1990s bull market and a below-average allocation during the disappointing markets of the 2000s, ISSG said.  That strategy would have been highly successful, according to the report.

However, Goldsticker cautioned that investors must thoughtfully evaluate back-tested results.  "They are only relevant if the future will look like the past.  I do not believe that markets will repeat the pattern of the past 20 years, the period over which many of the strategies were tested." 

He continued, "Volatility was relatively high between 1973 and 1990.  The period started with a bear market, but stocks performed well for the rest of the period.  It's just one example illustrating that the level of volatility is not necessarily linked to future market direction."

Volatility is determined by the level of economic uncertainty and by the level of investor risk aversion, which determines how strongly markets react to events as they unfold.  Neither of these factors is systematically linked to subsequent market direction, according to the report. 

Notes to Editors:

ISSG is part of the Bank of New York Mellon.

BNY Mellon Investment Management is one of the world's leading investment management organizations and one of the top U.S. wealth managers, with $1.3 trillion in assets under management. It encompasses BNY Mellon's affiliated investment management firms, wealth management services and global distribution companies. More information can be found at www.bnymellon.com.

BNY Mellon is a global financial services company focused on helping clients manage and service their financial assets, operating in 36 countries and serving more than 100 markets. BNY Mellon is a leading provider of financial services for institutions, corporations and high-net-worth individuals, offering superior investment management and investment services through a worldwide client-focused team. It has $27.1 trillion in assets under custody and administration and $1.3 trillion in assets under management, services $11.5 trillion in outstanding debt and processes global payments averaging $1.4 trillion per day. BNY Mellon is the corporate brand of The Bank of New York Mellon Corporation (NYSE: BK). Additional information is available on www.bnymellon.com or follow us on Twitter@BNYMellon.

All information source BNY Mellon as of June 30, 2012. This press release is qualified for issuance in the US only and is for information purposes only. It does not constitute an offer or solicitation of securities or investment services or an endorsement thereof in any jurisdiction or in any circumstance in which such offer or solicitation is unlawful or not authorized. This press release is issued by BNY Mellon Investment Management to members of the financial press and media and the information contained herein should not be construed as investment advice.  Past performance is not a guide to future performance.

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SOURCE BNY Mellon