Fund managers have a "critical" imperative to warn clients about the risks of chasing yield despite low volatility, former monetary policymakers have warned.
Volatility in financial markets has dissipated since the financial crisis in 2008, with the VIX US equity volatility index recently falling to its lowest level since February 2007.
The fall in volatility comes during an era of unprecedented stimulus from central banks whose actions have lifted prices of most asset classes.
But with volatility so long, economists are now warning investors are too focused on current levels, forgetting how turbulent investment markets can be.
Former Monetary Policy Committee member and London School of Economics professor Charles Goodhart said: “My worry is people are inclined to use very short-term models based on current volatility.
“There has been an incredible contraction of high yield spreads and I do think there is a danger that developed world investors have got themselves out on a limb on the assumption that low volatility will continue indefinitely.”
Fellow former monetary policy member and Wadhwani Asset Management founder Sushil Wadhwani said low volatility means this is a “critical” time to alert clients to the risks, even if they are pointing out short-term opportunities.
Goodhart and Wadhwani were speaking at an event on volatility hosted by Fathom Consulting, which questioned why the market has not priced in geopolitical risk, especially the oil markets, given the instability in oil-producing regions such as Russia, Iraq and Libya.
According to the consultancy, a spike in oil prices correlates closely with the beginning of a recession. One factor which may provoke a sharp upward turn in oil prices is stronger sanctions against Russia, it has suggested.
In June, Investment Week reported how low volatility has prompted some managers to invest in volatility as an asset class, using derivatives such as variance swaps or actively managed options portfolios.
