It may be a sad sign of the times that one index of market turbulence apparently isn’t enough. The Chicago Board Options Exchange’s Volatility Index, or VIX, has been around since 1993, but now State Street Global Markets has decided that the financial world needs seven more.
Thus, over the past year or so, State Street has started offering its clients a series of indexes that track and measure daily turbulence in seven markets: U.S. equities, European equities, currencies, U.S. fixed income, U.S. Treasuries, U.S. credit markets, and assorted global asset classes.
The indexes analyze publicly available information, such as commodity prices, to look for “abnormal” movements and returns. State Street claims that one reason its indexes are better than the VIX is that they can capture correlations between market segments. As the firm says, “the relative turbulence of a given day can result from the unusual performance of a single asset or from the extraordinary interaction between a combination of assets, which would not appear unusual in isolation.”
The company’s target audience is pension funds and other large institutional investors, as well as hedge fund managers, currency funds, and “other very active managers who use quantitative techniques,” according to Will Kinlaw, the managing director who runs State Street’s portfolio and risk management research. He wouldn’t disclose how many clients have signed up so far, other than to say, variously, that it’s a “decent” amount and “large.”
Great, so now money managers can know that they’re in a turbulent market. (As though they couldn’t tell just be looking at their own returns.) What can anyone do with that information? State Street says managers can stress-test the riskiness of their investment strategies and even adjust their asset allocation and risk exposure. Ideally, says Kinlaw’s colleague, managing director Daniel Farley -- State Street’s global head of multi-asset-class investments -- they would shift a bit out of equities and put about 10 percent into alternatives, including commodities and inflation-linked bonds.
Of course, there’s plenty of data from consulting firms like Hewitt Associates and Towers Watson showing that investors have been shifting out of stocks and into fixed income and alternatives ever since the financial meltdown, even without these turbulence measurements. Furthermore, haven’t we always been told that we shouldn’t panic or jettison our carefully thought-out, long-term asset allocation based on temporary market conditions?
Ah, Kinlaw says, but turbulence lasts 30 days, on average. That may indeed constitute long-term planning for hedge funds and currency traders, giving them plenty of time to adjust their strategies. For pension fund officials, however, 30 days is barely enough time to notify their investment committee of the date of the next quarterly meeting. By the time they actually sit down to discuss whether to change their investment strategy, the markets have already gone through two more rounds of “turbulence.”
So it’s not clear how much practical value these new indexes will have. Still, more information is usually a good thing. If we’re going to have to live with turbulence, we ought to have a way to understand and measure it.
Fran Hawthorne is the author of the award-winning “Pension Dumping” (Bloomberg Press) and “Inside the FDA: The Business and Politics behind the Drugs We Take and the Food We Eat” (John Wiley & Sons). She writes regularly about finance, health care, and business ethics.
