Thursday, December 21, 2017

"Jim Grant Interviews Alan Fournier: 'Pension Funds Are So Desperate For Yield, They're Systemically Selling Vol...'"

This is going on three weeks old but I just got to it last night and wanted it on the blog. It's important and the feedback loops could spin quickly out of control get very dynamic.

From ZeroHedge:
In the latest installment of Real Vision's interview series featuring Jim Grant, longtime publisher of Grant's Interest-Rate Observer, the newsletter publisher sits down with Alan Fournier, the billionaire founder of Pennant Capital, to discuss one of the most widely discussed topics across modern asset markets: Volatility - or rather, the systemic risks posed by not only the paucity of volatility in modern markets, but how risk parity and low-vol targeting strategies have created imbalances that could lead to massive dislocations should volatility spike. 

In the beginning of the talk, Fournier and Grant discuss how volatility has been artificially suppressed for so long that it's essentially become an asset class unto itself. Investors have devised all these new volatility targeting strategies - like risk parity, for example, that have generated outsize returns since the financial crisis. But many don't recognize the underlying risks. With so much money piled into the short-volatility trade, a large enough spike could trigger extremely painful selloffs in both bond and equity markets.
JG: And one would expect that if interest rates are going to turn, it might be kind of a noisy and dramatic turn.

Are you plugging in the interest rate aspect to this as well the bond market side of things?

AF: Well the thing that concerns me the most about this sort of overall technical setup, if you will, is that the reason people own bonds is they don't correlate with stocks. So if something bad happens in the stock markets, bonds rally, right? So risk parity, some stocks in a levered bond fund, it's been fabulous because that's been what we've seen for the last 15 or 20 years. Well if we get a turn, which is just driven by a normal business cycle and that correlation comes apart, who knows what happens? But there's a lot of money that's been dedicated to these kinds of strategies, whether they're vol targeting, risk parity. We're in sort of a spooky time.

JG: You use the phrase the setup, which I think is a wonderful way of expressing the notion of an overall context of things, how the forces are aligned or misaligned. And so many of those forces in this particular cyclical moment seem to be unusual if not unprecedented. Certainly the level, the nominal level and real level of interest rates is one of those forces. The positive preoccupation with the efficacy and with the certainty of outcome of passive investing must be another, right?

AF: Yes.

JG: And the peace and quiet in the markets as reflected in readings in both the MVE Index, which registers bond activity, and the VIX Index, which measures agitation in the stock market, those things are at record or near level lows. So Alan, how do you see the constellation of these forces?

AF: Well, we joke on a trading desk when we come in the morning if the futures are down-- like today they were down a bit this morning. But we joke about what time they're going to go positive during the day, and usually it's after the Europeans go to the pub or something at around 11 o'clock. By 2 o'clock they're positive.

And I just mentioned this because it's very unusual and something I've never seen in 30 years or so of doing this that sort of nothing rattles this market. And I think some of it is the vol being depressed.

JG: Now let's explain this. So volatility now, it's like a thing. It used to be stocks and bonds.

AF: It used to be observed based upon how options are priced. Now it's actually a source of income.

JG: Right. It's like an asset class.

AF: It's a bond.

JG: But it's movement. It's kind of capitalized movement, right?

AF: Right....

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