Monthly Archives

February 2018

How I Learned to Stop Worrying and Love the “Vol”

Maybe it’s because Valentine’s Day is approaching, but we have love on our mind after last week’s stock market gyrations.  We love volatility.  Always have.  Volatility is an active manager’s best friend.  Sure, we all know Buffett’s advice that long term investors who are still in saving mode should welcome down markets.  And while that nugget is true, our love for volatility goes deeper than that.

Volatility is a tailwind for fundamental, active investors who rebalance their portfolios.  Done properly, simply rebalancing a portfolio should lead to outperformance versus the benchmark.

Assume a 2-stock benchmark (no dividends.)  Each stock starts and ends the year at $20.  Much like the risk premiums in the market, the return of our imaginary benchmark is 0%.  Now, let’s add a little volatility and a rebalancing effort in one period.

Stock Price     Shares Held     Position Size    
Portfolio  
  Stock 1 Stock 2   Stock 1 Stock 2   Stock 1 Stock 2   Value % Chg
12/31/2017 $20.00 $20.00 100 100 $2,000 $2,000 $4,000  
6/30/2018 $18.00 $22.00 100 100 $1,800 $2,200 $4,000  
Rebalance       111 91   $2,000 $2,000   $4,000  
12/31/2018 $20.00 $20.00 111 91 $2,222 $1,818 $4,040 1.0%

 

We picked up 100 bp versus the benchmark!  What’s not to love?  Now let’s add a lot of volatility.

Stock Price     Shares Held     Position Size    
Portfolio  
  Stock 1 Stock 2   Stock 1 Stock 2   Stock 1 Stock 2   Value % Chg
12/31/2017 $20.00 $20.00 100 100 $2,000 $2,000 $4,000  
6/30/2018 $16.00 $24.00 100 100 $1,600 $2,400 $4,000  
Rebalance       125 83   $2,000 $2,000   $4,000  
12/31/2018 $20.00 $20.00 125 83 $2,500 $1,667 $4,167 4.2%

 

Whoa.  4.2% just from rebalancing.  Powerful love potion.  Our takeaway?  We believe a likely, sustained increase in volatility should lead allocators to fall in love with active managers, but we’ll have to wait to see if Cupid agrees.

We realize this is mostly a simple reversion-to-the-mean argument.  Well, we love simplicity, too.  That explanation might have to wait until next Valentine’s Day.  For now, bring on the “Vol”!

DISCLOSURES

This publication has been prepared by Azarias Capital Management, LP and is for informational purposes only.  Past performance is no guarantee of future results. The historical returns of the hypothetical investments mentioned in this commentary are not indicative of any future performance or the performance of any of our current or future investment strategies. The information provided is not intended as a complete analysis of every material fact regarding any market, industry, investment or strategy. Additionally, any views expressed by Azarias Capital Management, LP or its employees should not be construed as investment advice or a recommendation for any specific security or sector.

©Copyright 2017, Azarias Capital Management LP