These advisors hope for more volatile times

Traders work in the Volatility Index Options (VIX) pit on the floor of the Chicago Board Options Exchange (CBOE) in Chicago, Illinois, U.S.
Tim Boyle | Bloomberg | Getty Images
Traders work in the Volatility Index Options (VIX) pit on the floor of the Chicago Board Options Exchange (CBOE) in Chicago, Illinois, U.S.

Call it the market's "V" word for 2015.

That "V" would stand for "volatility," something investors have not seen, at least in sustained form, for several years.

With the Federal Reserve in extreme easing mode and stocks able to withstand virtually any challenge that comes their way, strategies banking on volatility have done poorly. The CBOE Volatility Index, while susceptible to the occasional flare up, has traded well below its historical average of 20 for a large chunk of the last five years or so.

That's kept correlations, or the tendency of prices to rise and fall in unison, at historically high levels. It's made diversification nearly irrelevant as an investment strategy, and has led to huge underperformance from active managers.

But at the 2014 Schwab IMPACT conference in Denver this week, there has been a lot of chatter about volatility returning to the market in the years ahead. Now that the Fed has eliminated its monthly bond buying program and is on course to start raising interest rates, there's belief that volatility will be a rising market theme.

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It's not that there's a lot of bearishness among the registered investment advisors in attendance—in fact, most believe the market is headed higher. It's just a belief that the path higher will become a little less predictable.

Direxion Investments, for instance, is trumpeting some of its products that protect investors when the VIX hits elevated levels. President Brian Jacobs said products such as the Direxion S&P 500 RC Volatility Response Shares exchange-traded fund will protect investors during times when the market's so-called fear gauge hits elevated levels. The fund has gained a healthy 13.8 percent over the past 12 months.

"From your lips to God's ears," was how Scott Silverman, senior vice president of sales at boutique asset manager AFAM/Innealta, reacted when asked whether he thought volatility would be an important investing theme in 2015.

He touted two of the firms' fairly new funds for the volatility play: the Innealta Capital Country Rotation and the Innealta Capital Tactical Fixed Income funds, both of which provide investors "granular" exposure to 40 international economies. The former fund has returned about 4.7 percent year to date, in line with its benchmark.

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That ability to diversify away from trouble spots in the market is a fairly popular theme.

"All of our competitors turn to cash positions (in times of turbulence)," Silverman said in an interview. "We go to a global, diversified multisector fixed-income portfolio. That makes us very unique."

From an equity standpoint, 361 Capital is introducing a long-short fund in a few weeks, with Analytic Investors, that also will focus on global opportunities. The strategy is fairly simple: Execute short-term trades buying companies that are oversold and selling those that are overbought.

At the root, though, is a strategy that relies on growing volatility and a better environment for finding mispriced assets.

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"This one has a bit more consistency in its profile," said Cliff Stanton, director of portfolio research and product management at 361. "A lot of long-short funds make larger bets on which way markets are going. In their case, they're trying to leverage academic research that says risk doesn't really pay in the equity market. That hasn't proven out."

Executives at Janus Funds, the firm that recently brought in Bill Gross to run its unconstrained fund, believes 2008-type volatility is not in the offings, but an increased level from the extreme complacency for the first half of 2014 is likely.

"Volatility is here to stay," said Mayur Saigal, global head of fixed income risk management at Janus. "The decade-low volatility numbers that we saw across asset classes (in June)—that was probably a good time to buy protection."

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