Skip to the content

Is the ‘fear index’ telling you to sell your equity funds?

24 August 2016

With the VIX – also known as the fear index – trading at one of its lowest levels in history, FE Trustnet analyses the returns investors have seen when general market volatility has been at similar level in the past.

By Alex Paget,

News Editor, FE Trustnet

Markets have been soaring since the UK voted to leave the European Union – though it seems that many don’t think this rally has legs.

According to FE Analytics, the FTSE 100 has made 9 per cent since the historic referendum while global equities (as measured by the MSCI AC World index) have rallied by close to 17 per cent.

However, as FE Trustnet has highlighted over recent weeks, cash levels across the IA UK All Companies and IA UK Equity Income sectors have reached three-year highs, equity funds have been hit by severe outflows across the board and discounts across UK equity trusts have widened considerably – suggesting both professional and private investors aren’t feeling too bullish about the outlook for risk assets.

There are various reasons why there is a sense of pessimism surrounding markets.

Brexit has certainly created a huge degree of economic and political uncertainty, the upcoming US presidential election could have wide-reaching ramifications and valuations have increased across the globe.

There is, therefore, the nagging concern that this rally has been driven by liquidity (currency weakness plus easing from central banks) rather than fundamentals, especially as economic growth remains anaemic.

However, another worry is that volatility has fallen off a cliff during the thin trading summer months – as shown by the VIX (or fear) index.

“Whilst markets are ‘making hay while the sun shines’ at the moment, it is important not to become complacent,” Whitechurch Securities said.

“The VIX index, which measures volatility of US shares and is widely known as a benchmark for investor fear recently hit the lowest level for two years. This seems somewhat complacent given the continued global economic and political uncertainty.”

Performance of VIX since November 2011

 

Source: FE Analytics

FE’s data on the VIX index spans back to November 1999 and, as the graph above shows, its major spikes over that time have been around the times of the 9/11 terrorist attacks, the global financial crisis, the European sovereign debt crisis and the events of 2015’s ‘Black Monday’ sell-off.

It also shows how volatility has fallen considerably since the start of the year.

Indeed, not only did the VIX hit its lowest level in two years recently, it also fell to its tenth lowest month-end data point since FE’s statistics began.


As Whitechurch noted in its most recent market commentary, while the VIX shows volatility levels in the US stock market (which tends to be a barometer of global markets as well), it has historically been a good measure of complacency among investors.

So, what sorts of returns have been generated when the VIX has fallen to these sorts of levels (or lower) in the past?

With the usual caveat that the past is no guide to future returns, as part of this study we looked at the performance of the FTSE All Share the last nine times the VIX was at a lower level than today since our records began.

We looked at returns over one month, three months, six months, one year, two years, three years, four years and five years – and the results were telling as, typically, equity investors lost money over the medium term.

Over those nine monthly data points on average, FE data shows the FTSE All Share lost 7.02 per cent on a two-year view and 8.15 per cent on a three-year view.

FTSE All Share’s average total returns when the VIX has traded lower than today

 

Source: FE Analytics

Interestingly, though, while the equity market tended to take a hit one month immediately after the VIX was at a low level, there were gradually better returns to be made on a three-month, six-month and one-year basis.

After losses over two and three years, though, the FTSE All Share generally began to recover over four and five years. Nevertheless, that would require investors to have had strong resolve given the market falls they would have had to sit through to receive those returns over four and five years.

Before investors start making any changes to the portfolio, though, it is worth noting that six of those nine monthly data points came during the bull market years of 2006 and 2007 prior to the global financial crisis when equities around the world suffered significant drawdowns.

Of course, those returns were generated when volatility was (in some cases, much) lower than it is today.

Luckily, though, there has been one point over the past 17 or so years when the VIX has traded at an almost identical level as it is today – in September 2005.

FTSE All Share’s total returns from September 2005

 

Source: FE Analytics

FE data shows that while the FTSE All Share initially fell close to 3 per cent over one month, there were decent returns to be made over the following months and years as the index moved into its pre-financial crisis bull market stage.


However, again, three years on from September 2005 and the index returned just 0.02 per cent as the fallout from Lehman Brothers’ collapse began to bite. Again, after a painful interlude though, investors would have made double-digit returns over four and five years – if they didn’t capitulate during the depths of the crisis. 

History suggests, however, that if this much anticipated correction in equities does occur and volatility spikes to very high levels as a result, investors can be rewarded for being ‘greedy when others are fearful’.

For this study, we also looked at the nine monthly data points when the VIX has reached its highest level and analysed the following returns from the FTSE All Share.

FTSE All Share’s average total returns when the VIX has been at its highest level

 

Source: FE Analytics

It’s safe to say, investors could have made an absolute killing.

Again, though this certainly doesn’t dictate future returns, the FTSE All Share – on average – gradually made better gains over one, three and six months when the VIX spiked in the past.

The returns over the medium term were even better, though, with the index producing an average return of 28.94 per cent over one year, 47.68 per cent over two years, 52.59 per cent over three years, 70.91 per cent over four years and a hefty 98.51 per cent over five years.

As before, most of those monthly data points were during the depths of the financial crisis. However, they also include the European sovereign debt crisis and December 2002 when the dotcom bust neared its climax.

 

FE Trustnet Registration

Editor's Picks

Loading...

Videos from BNY Mellon Investment Management

Loading...

Data provided by FE fundinfo. Care has been taken to ensure that the information is correct, but FE fundinfo neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.