The Risk Parity/ Short Vol Trade Just Blew Up

The risk-parity fund market rig is officially over.

Throughout 2017, I noted that “someone” was slamming the VIX lower to force risk-parity funds to buy stocks.

If you’re unfamiliar with risk-parity funds, they are meant to achieve “risk parity” for investors by buying or selling stocks and bonds based on the perceived risk in the markets via the VIX.

If the VIX is falling, meaning the perceived “risk” in the markets is falling these funds sell bonds and buy stocks.

If the VIX is rising, the perceived “risk” in the markets is rising these funds BUY bonds and SELL stocks.

The problem with all of this is that these actions are ENTIRELY based on algorithms, NOT human decision making.

Put another way, whatever the VIX does, these funds will be buying or selling stocks and bonds without judgment.

All told there were over $500 BILLION allocated to these funds globally. So… if you wanted to force a stock market rally, all you needed to do is push the VIX lower and BOOM, you’ve got $200 billion or so in buying pressure hitting the stock market.

This market rig occurred almost daily throughout 2017. And the end result was two fold:

  • Retail “mom and pop” investors came into the stock market in ways not seen since the Tech Bubble.
  • “Shorting volatility” became one of the most crowded trades in the world.

Regarding #1, while it’s true that roughly half of American households have exposure to stocks, the reality is that the bulk of this is from indirect investment strategies like 401(k)s and retirement accounts.

Put another way, rarely do Americans go an open brokerage accounts themselves to start directly investing in stocks. The two most recent occasions were the Tech Bubble in the late ‘90s and today.

Indeed, discount broker TD Ameritrade noted that retail investors were more exposed to the stock market in 2017 than at any other period in history. The CEO for the firm noted that client cash levels were at the lowest in history.

Put another way, “mom and pop” investors were “all in” on stocks. And much of this enthusiasm was due to the market going straight up courtesy of the risk-parity fund gimmick I mentioned earlier.

The other problem with the risk-parity fund market rig is that it convinced investors that “shorting volatility” was a virtual ATM. It became so insane that at the end of 2017, Short Vol. ETFs were larger than ETFs for entire countries.

In fact, regardless of direction, volatility itself is an in-demand asset class. The popularity of volatility products far outweighs that of other prominent corners in the U.S.-listed ETF market. With $4.6 billion in assets, they are larger than funds tracking any single European country, other than Germany. They also have more assets than those tracking all frontier markets and all ESG (environmental, social and governance) strategies combined.

Source: Bloomberg.

This whole scheme is now over. As I write this, some of the short-Vol ETFs have collapsed over 60% in the after hours. And risk-parity fund selling of stocks has just begun.

Indeed, it’s very possible that the Everything Bubble I’ve been writing about for years has begun to burst. The time to prepare your portfolio is NOW before things really get ugly.

On that note, we are putting together an Executive Summary outlining all of these issues as well as what’s in terms of Fed Policy when The Everything Bubble bursts.

It will be available exclusively to our clients. If you’d like to have a copy delivered to your inbox when it’s completed, you can join the wait-list here:

Best Regards

Graham Summers

Chief Market Strategist

Phoenix Capital Research




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What Happens When the Everything Bubble Bursts?
  • By trying to corner the bond market (risk-free rate)
  • the Fed has created a bubble in everything
  • Reserve your copy of our Executive Summary
  • To prepare for what's coming down the pike!