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<\/a>Volatility regimes are decisive for most investment approaches, particularly hedge funds. For both top down players
\n(CTAs, Global Macro, FI Sovereign Arb.) and bottom-up strategies (L\/S Equity, Event Driven, Credit Arb.), volatility
\ndeeply influence their universe and the trendiness of opportunities. <\/p>\n
Volatility regimes are determined by a wide set of drivers, which influence one another. It takes a coalition of drivers
\nto alter volatility regimes, requiring a 360\u00b0 analysis to anticipate volatility trends. Upstream, macro volatility is paced
\nby inflections of the business cycle, dispersion across world economies, swings in monetary policies and credit
\nconditions, as well as by other tail and geopolitical factors. Macro volatility reverberates at a micro level, affecting
\nhouseholds and corporate fundamentals. In turn, both households and companies accumulate actual and\/or
\nperceived risks and imbalances (through leverage, shifting income\/profits, etc.), which finally spread to market
\nvolatility. Turning flows are primary movers for market volatility, triggered by changing macro and micro risks as
\nwell as by changing market patterns (trading leverage, imbalanced positioning, stretched valuations etc.). However,
\nas volatility became a key input for risk taking (setting leverage and asset allocation targets) and an asset class on
\nits own, volatility has also become its own mover in a circular reference. When direct and indirect short-volatility
\nexposures pile up, investors become vulnerable to non-linear deleveraging and sudden asset re-correlation known
\nas gamma and correlation risks. Several volatility flash crashes came as reminder. <\/p>\n
With these drivers in mind, which run upstream to downstream and vice versa, we believe that the days of ultralow volatility (<15 for G3 equities) are behind. Since 2018, factors such as an ageing cycle, multiple geopolitical\nrisks, a global economic deceleration have largely contributed to the rise. Yet, volatility is still a long way from late\ncycle levels. Massive monetary injections are offsetting some of the above pressures and curb economic volatility.\nThey help keep market volatility in a mean-reverting pattern, witnessed by series of volatility spikes rapidly faded\nor by a negative volatility auto-correlation. Moreover, volatility is capped by sustained short-volatility flows from\ndirect volatility allocations, as well as risk-premia, risk-parity or volatility-targeting strategies. All in all, mixed\nvolatility drivers (summarized on the table) could keep G3 volatility around 20 for now, but the more short-volatility\nflows stack up, the closer we get to a high volatility regime. Central banks reaching their limits, the slowing growth\nof buybacks (which buy equities on\nweakness and distort valuations) and\npassive products (which crush dispersion)\ncould also contribute to a structural inflection. \n\nIn the meantime, consequences from\nhigher volatility \u2013 be it constrained \u2013 are\nemerging in trading and alpha generation\nconditions. There are evidences of more\nfundamental discrimination (equity\/credit\nissuers respond more closely to their\nfundamentals). Equity\/credit dispersion is\nnow firmly off from lows back to average.\n\nUltimately, higher macro volatility would\nalso result in more themes to exploit.\nAs we slowly and steadily march toward a\nhigher volatility regime, bottom-up pickers\nmight be the prime initial beneficiaries,\nlater relayed by top-down strategies. \n\n<\/a>