Aspects of volatility targeting for South African equity investors

Bhekinkosi Khuzwayo,Eben Mare

doi:10.4102/sajems.v17i5.662

Abstract

We consider so-called volatility targeting strategies in the South African equity market. These strategies are aimed at keeping the volatility of a portfolio consisting of a risky asset, typically an equity index, and cash fixed. This is done by changing the allocation of the assets based on an indicator of the future volatility of the risky asset. We use the three month rolling implied volatility as an indicator of future volatility to influence our asset allocation. We compare investments based on different volatility targets to the performance of bonds, equities, property as well as the Absolute Return peer mean. We examine risk and return characteristics of the volatility targeting strategy as compared to different asset classes.

Highlights

Volatility targeting strategies aim to allocate between cash and a risky asset, typically an equity index, with the aim to keep the overall volatility of the strategy stable at a targeted level
We have examined the performance of volatility targeting strategies for the All Share index by making use of implied volatility as a signalling factor
We compared the performance of these strategies to the returns of traditional asset classes in the South African market including the Absolute Return peer universe

Summary

Introduction

Volatility targeting strategies aim to allocate between cash and a risky asset, typically an equity index, with the aim to keep the overall volatility of the strategy stable at a targeted level. Volatility targeting holds the promise of higher risk-adjusted returns (as well as decreased tail-risks) relative to a static asset allocation, see for example, Ribeiro and Di Pietro (2008) and De Rossi and Nakisa (2011). The latter authors note that a study of volatility controlled strategies leads to insights for fund managers typically constrained by targeted tracking error mandates which in turn are directly impacted by market volatility. Africa TOP40 risk target indices’ or the ‘risk target indices’ These indices are set to target 10, 15 and 20 per cent volatility on an excess and total return basis, respectively.

Aspects of volatility targeting

Risk and return comparisons

Findings

Conclusions and future research