Sayings on Vol and Risk...A Fresh Five

Greetings and salutations loyal listeners, welcome to what promises to be another exciting addition to our Sayings on Vol and Risk. To set the table, last year, I did a 5-part series with 25 Sayings. These are concise statements I’ve wound up using many times over during the course of my career to help myself and others think about market risk. These pitchy proverbs are market maxims that explore the drivers of unanticipated change in asset prices.   With the first 25 saying completed in 2024, I recently added 5 new ones, getting us to 30. This podcast gets us to 35 in total. Hope you enjoy and find interesting. 31. “Risk management suffers from a failure of imagination.”32. “Markets are a never say never business.”33. “Broken markets break down.” ~ Mike O’Rourke, Jones Trading34. “This is not your father’s ETF market.”35. “Doubt is not a pleasant condition, but certainty is an absurd one.” ~ Voltaire

Today’s world of ETFs and mutual funds increasingly features new flavors, a popular one of which is derived from embedding optionality. There are plenty of ways in which one might contemplate risk managing and shaping the distribution of equity returns using options. Common strategies like overwriting create income, but limit upside. Others like the zero cost collars create both upside and downside guardrails on returns. These strategies can be back-tested. Because they also exist in the market, with more than $200bln in AuM, the performance of the funds can be evaluated as well. With this in mind, it was a pleasure to welcome Dan Villalon, Global Co-Head of Portfolio Solutions at AQR Capital Management, back to the Alpha Exchange. Dan walks us through the findings from his research, published in a two-part series on the AQR website. In these notes, Dan dissects the drawdowns and returns across these funds. The findings are rather striking: across a wide sample of buffered funds and option-based strategies, very few delivered both higher returns and smaller drawdowns. In fact, most underperformed their beta-adjusted benchmarks on both fronts—meaning they not only lagged in returns but also failed to meaningfully protect against losses in periods like the COVID crash, the 2022 inflation-driven drawdown, and the volatility of early 2025. Even strategies designed explicitly for downside protection often fell short when it mattered most. I am a big believer in option strategies and in the value of the SPX options market as a vehicle to transfer risk. These results were a surprise to me.Dan outlines three key drivers: the persistent cost of buying options, the structural frictions involved in implementation, and the surprisingly high management fees for such rules-based products. Dan also introduces a more behavioral theory—what he calls the "placebo effect": the idea that investors feel safer simply because they're told they’re protected, even when the data shows otherwise. I hope you enjoy this episode of the Alpha Exchange, my conversation with Dan Villalon.

With nearly three decades at BlackRock, Mitch Garfin brings a deep well of experience to his role as Co-head of Leveraged Finance, overseeing high yield and leveraged loan strategies for the firm. In this episode, we explore the evolution of the credit landscape — from structural shifts in the high-yield market that leave indices of higher credit quality to managing risk in a world of tight spreads but always shifting macro narratives.Mitch shares how his team navigates dispersion, with recent focus on considering the implication of tariffs on different sectors. His team positioned for tariff-related volatility by reducing exposure to sectors like autos and consumer products perceived as most exposed to trade policy risk. Conversely, Mitch saw better value in the tech and insurance sectors.Next, we discuss advancements in trading technology and the implications for liquidity. Here, he argues that the electronification of credit markets and the growth in portfolio trading is having profound impact on risk transfer, reducing frictions and transaction costs. In the process, he shares how his team leverages tools like ETFs and the CDX product to manage exposure.I hope you enjoy this episode of the Alpha Exchange, my conversation with Mitch Garfin.

In 2024, I did a 5-part podcast series called “25 Sayings on Vol and Risk”.  These are observations I’ve found do a nice job of describing how markets work, or perhaps better said, how markets sometimes fail to work. Because markets are always teaching us lessons, I couldn’t help but add to the original 25 with five new sayings. I’ll follow up in short order with another five.Here are our Sayings 26-30: “Financial market objects at rest tend to stay at rest.” “Realized vol rules the world.” “My portfolio is more diversified and liquid than I thought, said no one ever.” “The ten-year note, not the SPX, is the risk asset.” “Shake hands with the government and sell what they’re selling.” Hope you Enjoy!

As Global Head of Equity Derivatives Research at Bank of America Merrill Lynch, Ben Bowler is helping the firm’s institutional client base understand the complex risk dynamics that impose themselves on today’s markets. His process often leads him across asset classes, looking for linkages and developing stress indices that may provide early warning signs for US equity markets.Our discussion first considers the recent SPX vol event, which, from a short-term severity standpoint, Ben puts in a category with the GFC and Covid. He further makes the point that since the Tariff uncertainty was self-imposed, it was as if we were in the midst of the Covid crisis but already had the vaccine in hand.We then explore the work that Ben and his team have done on the concept of fragility. Here, he argues that the speed and magnitude of vol spikes, flash crashes and tantrum in markets has increased. In fact, in US single stocks, he suggests that fragility is at an all-time high with the reaction to earnings faster and more violent. Two factors may be playing a role. First, there is substantial crowding in certain risk exposures, like large cap tech. And second, liquidity provision, increasingly electronic in nature and sometimes rapidly withdrawn during times of stress.Lastly, we discuss the history of innovation and how investors have generally pulled forward the benefits of path-breaking new technologies, leading to asset price bubbles. Here, Ben is thinking about right tail risk and how important optionality may be in hedging the risk that the AI bubble could inflate substantially.I hope you enjoy this episode of the Alpha Exchange, my conversation with Ben Bowler.

Corey Hoffstein, the Co-Founder and CIO of Newfound Research is among the investors expanding the financial product set available to the RIA community. A client segment that has long been fed a diet of 60/40 exposures, the high-net-worth community is finding the need to diversify beyond stock and bond exposure. Using their innovative approach to return stacking, Corey and team are making alternative sources of risk premium accessible and packaged in an ETF format.Through our conversation, we first learn that from a behavioral standpoint, introducing entirely new securities with new exposures has been a challenging ask. With return stacking, the diversifying strategy is put on top of an existing stock or bond exposure, packaged in one security. We discuss Corey’s recent white paper, comparing the risk characteristics of corporate bonds to that of merger arbitrage and how each exposure interacts with stock and bond markets. He finds the correlation of risk arbitrage returns to those of the equity market are lower than corporate bond spreads to equities.We also review a realm of trading strategies that Corey has focused on substantially over the years, trend following. He walks through the manner in which trend can be defensive and how it behaved specifically over this recent significant market drawdown. We finish by getting some of Corey’s thoughts on the broad topic of risk premiums and which like merger arb and vol selling ought to be persistent sources of compensation.I hope you enjoy this episode of the Alpha Exchange, my conversation with Corey Hoffstein.

In six short trading days from 4/2 to 4/9, the SPX realized as much vol as it did during the ENTIRE year of 2024. The protracted risk-off that began with the “Liberation Day” fallout ranks only behind Covid and the GFC in terms of severity using data going back to 1990. While we've likely moved past peak VIX, in the aftermath of recent chaos is an overhang of uncertainty that may hamper critical decision-making. I see plenty of lingering uncertainties - from the uneven communication from the WH, from the unpriced reactions of our trading partners and from how the market will need to price in the potential economic and corporate profit fallout from the last several weeks. Unfortunately, the recent period has been a totally unforced exercise in negative branding for both the dollar and US government bond market. For the VIX to run to 50 and for duration not to rally concurrently is a bad outcome, amounting to an asset pricing taste test that went poorly. Scott Bessent and Company need to more effectively safeguard one of our most prized possessions, the US government bond market. The Ten-Year note, not the SPX, is the risk asset. The real financial tail risk that would bring about a spiral higher in the VIX would seem to lie in the potential that long-dated UST yields rise quickly. From a contagion standpoint, the Ten Year is the vulnerability. It’s not being treated as such. I hope you find this useful. Have a great week. 

For Matt King, evaluating market risk is often about pinpointing vulnerabilities within the financial system. Over the many years he's been advising institutional investors, he's gone where the action is - in the dotcom era it was corporate balance sheets, in the pre-GFC period it was asset-backed CP and in the last decade it's been sovereigns and QE. Now the founder of Satori Insights, Matt shared his current assessment of risk on this episode of the Alpha Exchange.  His materially bearish take is a function of what he views as US trade policy underpinned by both a misunderstanding of balance of payments math and a failure to appreciate the risks of chaotic implementation. On the latter, Matt worries that the US is earning itself a risk premium in the back end of its bond market, a troubling development especially set against the ever-growing pile of debt outstanding. Matt shows the spike in US real rates at a time when the VIX was also surging and the dollar falling as similar to the UK's "Liz Truss moment" in 2022, an event that forced the Bank of England to act quickly. Matt argues that while Democracy ought to be mean-reverting - where bad policy leads to bad outcomes and declining popularity, ultimately motivating a change of course, today's setup in the US is one in which bad policies impact growth and further poison our politics, reinforcing bad policy. Stepping back, he sees value in gold, noting that both gold and FX vol are still too low. I hope you enjoy this episode of the Alpha Exchange, my conversation with Matt King.

Market risk events come in all shapes and sizes, originating from unique sources of uncertainty. We've seen them all - valuation bubble unwinds, mortgage credit crashes, Fed policy shocks, even the shutdown of the US economy from Covid. Over the last month, investors have been forced to confront a new risk, that of the imposition of substantial tariffs by the US on its trading partners. With this in mind, it was great to welcome Steven Englander, Global Head of G10 FX Research of Standard and Chartered Bank, back to the Alpha Exchange. Our discussion begins with Steven's assessment of the setup coming in to 2025 and that was one in which the market was long dollars in anticipation of the Trump agenda.We next talk about balance of payments identity math and how it is difficult to solve simultaneously for a lower trade deficit, higher direct investment from abroad and lower US interest rates. He suggests, however, that the speed with which asset prices moved in March and April, have complicated the decision-making process for investors thinking about making investments into the US. We next explore the factors driving the dollar lower. Here, in addition to noting that implied Fed cuts have increased by 50bps over the last month, Steven also suggests that a risk premium may be assigned by foreign investors to US assets. He points as well to pessimism about the US economy, noting that this is not yet showing up in the hard data.There's much more to learn about Steven's framework in our discussion, which I do hope you enjoy. 

Lenin purportedly said, “There are decades where nothing happens; and there are weeks where decades happen.” It’s difficult to understate how highly consequential these past few days have been. We live in an interconnected world of international rivalries, debt, trade, asset prices and economies. All kinds of tail probabilities become more live when a shock of this magnitude occurs. From a market standpoint, however, the higher vol goes, the greater likelihood that government officials blink in some way. The scars from the market chaos of the GFC and Covid remain and the lesson is not to create hard to fix but also urgent problems in the financial system. With this in mind, there could be an opportunity to fade the exceptionally high VIX level. I hope you find this discussion useful.