Friday 28th of December 2007

Volatility has increased in equity markets generally, and particularly in the U.S., where investors are increasingly nervous about the continued effects of the credit event and potential for recession some time next year, an article by Standard & Poor's Investment Consulting reveals today. Over the 115 trading days to the Federal Reserve's rate cut on Tuesday night, there have been 46 days on which the S&P 500 has moved, either positively or negatively, by more than 1%. This compares with just 16 days in the 115 days before the end of June 2007. That volatility has increased tells us that market participants are experiencing much greater uncertainty than previously. "It does not tell us whether that increase in uncertainty is warranted," said Simon Ibbetson, director of S&P Investment Consulting, "or whether investors should have been feeling greater fear before August. Neither does it tell us whether heightened uncertainty will continue, but looked at in the context of the VIX index, otherwise known as the 'investor fear gauge', it does show that the extent of differing views in the market has moved back to levels considered normal during the period between 1998 and 2002". Those five years included a very strong bull-market run, followed by a fairly severe, if relatively short-term, bear market in U.S. equities. "Volatility is not necessarily a bear-market characteristic", Mr. Ibbetson added. "Given the range of uncertainties in the equity market, and the ongoing problems in the credit markets though, it would seem likely that volatility will not return to the low levels seen in recent years." Theoretically, more turbulent markets should benefit certain hedge-fund strategies, some of which have been becalmed at times during the bull market as volatility has fallen. Investors in hedge funds that have done extraordinarily well in low-volatility markets may be suspicious of their success. For example, how much of the returns of a top-performing manager have been achieved using beta strategies that, by rights, should not have substantial fees attached to them? Perhaps counterintuitively, long-standing hedge funds that have struggled to perform and justify their fees may actually have been "true to label". The upcoming environment should provide investors with better opportunities to gauge the success of managers claiming skill in managing alternative mandates. A longer version of this article is available by contacting Standard & Poor's Investment Services.