VTS Community,

An interesting question here from Alvin:

“What’s the best benchmark to measure the performance of volatility trading against?”

This is a great question and one that doesn’t really have a specific answer but let me elaborate a little bit.  In my opinion investment performance isn’t focused on nearly enough in the financial industry which is bizarre because what could be more important than that?  Sure good service, tax and estate planning, budgeting etc are all important, but it seems all too common to me for industry professionals to focus almost entirely on those things and very little on actual investment performance.  I’ve always believed it should be a requirement of anyone claiming an expertise in investing to actually report performance.  Is it really that difficult?  Just track a model portfolio and post the performance, easy.  If the manager has a few different methods based on risk tolerance that’s fine, track three.  That way everybody can make honest and fair comparisons between managers and the free market will take care of the rest.

Unfortunately, this isn’t the case.  It’s hard to put a number on it but I would estimate at least 90% of “investment professionals” don’t have anywhere you can view any performance at all.  Hedge funds do by regulation, and ETFs and Mutual funds, but for the vast numbers of financial advisors out there it’s all a mystery until you actually fork over money and try it out.  And I’ve talked about the statistics before how roughly 85% of them underperform their benchmark.

I certainly understand why very few people do what I do with reported performance and voluntarily holding your feet to the fire.  It would end their career in most cases but should that be the investor’s burden to bear?  Why don’t regulators demand it?  If they really want to protect investors, why isn’t performance reporting mandatory for everyone?  Say what you want about hedge fund managers, but at least they show their numbers…

Do golfers get to not tell anybody what they shot?  Do they get to just say:  “Take my word for it, I’m awesome, where’s my trophy?”  Uh no thanks, post your scorecard and the public will be the judge of how good you are… 

 

If you’re a stock trader, easy, use the S&P 500.  If you’re a bond trader, go with the Vanguard Total Bond Index.  But what about volatility?  What benchmarks can people use?

 

1)  S&P 500.  I feel like since equities are usually in the higher risk category of a portfolio, and investing in volatility products would be in the same higher risk category, it’s not a bad idea to just compare to the S&P 500.

I did a video on this about a year ago you can check out below giving a few reasons why the S&P 500 is a good benchmark.

@ 3:27 of the video is interesting.  Warning, XIV danger ahead 🙂

 

2)  CBOE Eurekahedge Volatility Index.  I introduced this in a previous article here, but here’s the breakdown of what it is straight from their website:

The CBOE Eurekahedge Volatility Indexes is a suite of 4 indices developed by Eurekahedge with the support of the Chicago Board Options Exchange (CBOE).  With a total of 60 constituents, these indices aim to carefully measure the performances of hedge funds investing in volatility and thus, provide a new benchmark in the alternative investment industry to help professionals comparing their returns with their peers.”

So if you’re investing in volatility products or options trading, anything to do with volatility markets I would say this is your best bet for the closest benchmark.  This is a decent representation of what the performance looks like when fund managers out there say they are “volatility investors” so if you can beat this you’re doing better than most Wall Street bigwigs  🙂

 

Now I would use this as well because everything we do is also volatility specific, but to be honest the only reason I don’t use this and instead I choose either the S&P 500 or the Vanguard VBINX is because when I match up my performance against it, it makes the CBOE Volatility Index look like a flat line.

I don’t like to ever risk giving people the impression that I’m trying to cherry pick the worst benchmark.  Even though fund managers do that all the time, I still don’t want to give that impression so I always choose both relevant and top performing benchmarks to compare to.  In the case of Options Trading it doesn’t make much sense to use anything else, but for our volatility strategies, I still use the S&P 500.  The CBOE Eurekahedge Volatility Index just looks flat and hardly worth putting on a chart.

 

* US markets will be closed on Monday, September 3rd for Labour Day, and it’s my birthday too so although I’m not American I will be celebrating a little bit as well.

Have a fantastic long weekend everyone!

 

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