The Case for Managing Volatility as an Asset Class

When budding entrepreneurs receive a boatload of shares of their likely-to-go public startup, those with financial planners often end up hedging those bets by selling some shares.

In so doing, they may limit their upside but also lock in a minimum net worth and protect themselves from losing everything if those share prices drop to zero, an all-too common occurrence. The strategy has kept many an entrepreneur from being wiped out when his company failed to take off.

What if a similar strategy could work for average investors facing the prospect of future downturns like the one in 2008?

Brendan Clark, president of RIA and SMA manager Clark Capital Management Group in Philadelphia, thinks it can. He recommends that planners hedge large corrections by treating volatility as an asset class that can be managed.

Launched in 2004, Clark's Navigator Global Equity ETF Hedged Strategy, which used this strategy, lost 20.6% compared with 37% for the S&P 500 in the 2008 market collapse, he says.

"On average, we see a 30% to 40% reduction in risk by introducing volatility risk," Clark says. The firm's Navigator Investment Solutions include SMAs, UMAs, mutual funds and ETF portfolios.

Studying historical data for the past century, Clark says he found that the markets tend to have a couple of 5% pullbacks annually, and maybe one 10% correction. He isn't worried about those.

"We are not trying to hedge away those corrections," he says. "We're trying to hedge away those life corrections in the 30% or 40% range so that your client who is in retirement doesn't have that life-changing event where he wakes up one morning and his portfolio is [severely] cut."

Clark's strategy is based on his observation that major asset classes that once behaved in a non-correlated manner have begun to mirror each other.

"Through increased globalization," he says, "we've seen correlations among all risky assets continue to march higher. That means that the benefits of diversification are much harder to discern today than we could find in the '90s or the '80s."

That amounts to less-differentiated performance between international stocks and domestic stocks, and between real estate and commodities and stocks, Clark thinks.

To hedge for risk, Clark deploys a strategy of S&P 500 put options. He also uses the VIX, which provides a measure of expected volatility in the market in the coming 30 days.

Constructing an investment strategy around volatility helped vault Clark into the SMA space. Then operating solely as an RIA, Clark Capital emerged from the dot-com meltdown of 2000 with a conviction that volatility needed to be addressed differently. That lead to the development of the company's volatility strategy which, he says, is available on some of the largest B-D platforms, including LPL Financial.

In 2003, Clark Capital managed between $250 million and $300 million in AUM. Now, with its SMAs, it is managing close to $3 billion.

After 2008, Clark says he saw a boom in referrals from advisors because its strategy helps persuade investors to stay the course and not get derailed during downturns.
"It gives them a greater likelihood of staying involved [in the markets] and committed to the overall financial plan so that they can reach their goals with their advisors," he says. "For the advisor, that helps with retention."

Ann Marsh writes for Financial Planning.

For reprint and licensing requests for this article, click here.
Investment products
MORE FROM FINANCIAL PLANNING