As a result of the ongoing US-China trade war, desynchronized global growth, and continued interest rate sensitivity market-wide, investment professionals are likely to hear a lot of market watchers talk about volatility in the months ahead, while keeping an eye on the Chicago Board Options Exchange Volatility Index® (VIX).1 Will risk increase? Will it stay the same? Many have opinions, but no one can predict the future. That's why it's important to have a baseline understanding about market risk. Our observation is that some of the publicly available information on market risk may be understood by some investors, but too advanced for others.

We’ve created the following quiz to help investment professionals and their clients gain an improved understanding of market volatility and to help improve their knowledge of what investment strategies are available to help manage it.

True or False: Market volatility typically measures how much equity markets go up and down for different periods?

True. This is normally represented by the standard deviation2 of an asset or investment strategy’s returns. A higher standard deviation value can signify more risk, and a lower standard deviation value can signify less risk.

What asset classes generally have more market volatility, equity or fixed income?

Typically, equity has more risk/volatility, but there are exceptions to this rule. Be sure to check the specific asset class or investment strategy for relevant risk information.

True or False: There are strategies that allow investors to participate in equity market returns, but do so in a lower-risk way through the ownership of certain types of equities.

True. Lower volatility equity strategies are designed to provide investors with market exposure, but to do so with less risk. These are used by some investors as a long-term position in portfolios, while others use these strategies tactically, when they are concerned about future market volatility. Retail investors can use exchange-traded funds (ETFs)3 or mutual funds designed to decrease overall risk exposure.

Are US or International equity markets generally more volatile?

Historically, international markets. If one uses the S&P 500®,4 the MSCI EAFE5 and the MSCI Emerging Markets Index6 as barometers of US, non-US developed, and emerging market risk, then the data tells us that international markets have historically been more volatile.

Are investment strategies designed to help decrease the potential effects of volatility used only by retail investors, or do institutional use them too?

Institutions can also use strategies designed to help decrease the potential effects of volatility on a portfolio. A large number of institutional investors use strategies designed to decrease the potential effects of volatility. Many of these investors prioritize risk-adjusted returns,7 over absolute returns, which is what many lower volatility strategies seek to do as well.

Is there a difference between low volatility and minimum volatility investment strategies?

Yes. Low volatility strategies often only seek stocks with the lowest historical risk, while minimum volatility strategies typically seek both low risk stocks and those that demonstrate strong diversification relative to each other.

True or False: Some lower volatility strategies can offer enhanced diversification to investors, in addition to offering them potentially lower risk than an index.

True. A good way to find this out is to ask your low volatility money manager what their beta8 is compared to the market they are seeking to track or seeking to outperform. A beta measurement of 1 indicates that a security’s price moves with the market. A beta measurement of less than one suggests the security is less volatile than the market, while a beta of greater than one suggests the security is more volatile than the market. Some managers are able to produce strong returns, while having a low beta. This can signal strong diversification value, since the returns are being generated without carrying all the volatility of the market.

Does the Chicago Board Options Exchange Volatility Index® (VIX)8 measure historical US equity market risk or does it measure what is expected by experts in the near term?

The VIX measures what experts expect for risk in the future, since the index evaluates the options being bought and sold in the markets and what investors are willing to pay for different levels of volatility protection. Tactical investors, or those seeking to actively trade their investment portfolio, often buy lower volatility investment strategies when they expect the VIX to rise.
In our estimation, a score of 6 or better on the above quiz represents a solid baseline understanding of volatility. Regardless, we think these questions provide insight into forming a more complete understanding of volatility – one that may prove useful to financial professionals and their clients as they seek to make sound investment decisions and accomplish their financial objectives.
1 The CBOE Volatility Index (the VIX) measures expected future (30-day) volatility of the S&P 500® Index and is derived from the prices of S&P 500® Index options. An option is a contract that gives its owner the right, but not the obligation, to sell a specified amount of an underlying security at a specified price within a specified time.

2 Standard deviation is a measure of the distribution of a set of data from its mean, or average value.

3 An exchange-traded fund, or ETF, is a marketable security that tracks an index, commodity, bonds, or a basket of assets like an index fund. ETFs trade like stocks, are subject to investment risk, and will fluctuate in market value. Unlike mutual funds, ETF shares are bought and sold at market price, which may be higher or lower than the ETF's net asset value.

4 The S&P (Standard & Poor's) 500 Index is an index of 500 stocks often used to represent the US stock market.

5 The MSCI EAFE Index is a stock market index designed to measure the equity market performance of developed markets outside of the U.S. & Canada. EAFE stands for Europe, Australasia, and Far East.

6 The MSCI Emerging Markets Index consists of 23 countries representing 10% of world market capitalization.

7 Risk-adjusted return refines and investment's return by measuring how much risk is involved in producing that return, which is expressed as a number or rating. Risk-adjusted returns are applied to individual securities, investment funds, and portfolios.

8 Beta is a measure of the volatility, or systematic risk, of a security or a portfolio in comparison to the market as a whole.

Volatility management techniques may result in periods of loss and underperformance, may limit the Fund's ability to participate in rising markets and may increase transaction costs.

This material is provided for informational purposes only and should not be construed as investment advice. The views and opinions expressed above may change based on market and other conditions. There can be no assurance that developments will transpire as forecasted.

All investing involves risk, including the risk of loss. Diversification does not guarantee a profit or protect against a loss.

Fixed income securities may carry one or more of the following risks: credit, interest rate (as interest rates rise bond prices usually fall), inflation and liquidity.

Equity securities are volatile and can decline significantly in response to broad market and economic conditions.