A Steady Vol Strategy

The art and skulduggery of finance is infused with uncertainty.

So, how about we try to smooth volatility a little and see the consequences?

The VIX predicts the volatility of the S&P 500 for the next thirty days.

Our Steady Vol strategy takes the inverse of the current VIX and weighs our holding in the S&P 500 accordingly.

If predictions of volatility increase, we reduce our holding of the S&P 500, and vice versa.

weight.INDEX_GSPC = 1/latestVix;

(See the code for my Backtest IDE here)

The volatility of our Steady Vol's returns stays consistent over time.

In fact the standard deviation of annual standard deviations is only 2.5% compared to 7%.

Over the whole 25 years, the Steady Vol strategy's Sharpe accrues about a third more than the plain S&P 500 (0.6 vs 0.45).

On a yearly basis both Sharpe ratios are indistinguishable however.

I suspect the Steady Vol accrues very small compounded return wins over the short term (such as avoiding large losses) leading to very large gains in the long term.

As I have written about before, no one invests in anything halfway exotic for 25 years straight. Unfortunately the Steady Vol strategy doesn't deliver steadier yearly Sharpe ratios - if anything it is slightly inferior over the short term!

Perhaps over the medium term I can show steadier risk adjusted performance - in a future post.