When Volatility Attacked
December’s market volatility was what most investors would expect to see only in a stress test scenario. The VIX jumped from 16 to 36 and back down to 25 all in the span of one month. We talked to Dave O’Donohue, Senior Vice President and Co-Portfolio Manager, about how he and the Calamos Market Neutral Income Fund (CMNIX) and Calamos Hedged Equity Income Fund (CIHEX) team view volatility and how they reacted to the big swings in volatility during December.
Q. Dave, would you step us through what you saw in December?
A. It was a wild month, but we tend to get excited when we have increases in volatility because it can present opportunity for the funds. When there’s too much volatility, though, we need to shift our focus from the opportunity to the risk.
As part of our standard risk management practices, we continually stress-test our portfolios—we run “shocks” for different extreme scenarios. That’s what we had in December: a real-life example of a downside stress test.
In one month’s time the S&P 500 dropped 15%, the VIX more than doubled, and there was a 200-basis point widening of credit spreads from their October tights.
Those are the ingredients for a classic, but extreme, downside shock scenario. Any one of those components is a stressor that can expose weaknesses in a process and in a portfolio, and we saw all three at the same time.
Q. Do extreme shocks present a challenge for your active approach?
A. It’s a challenge.
We believe one of the strengths to our process is our dynamic approach. Ideally, we can take advantage of market movements to monetize and readjust our hedges. In falling markets we can cover calls we have written or roll down/readjust our puts, and in rising markets we can add puts or roll up/readjust our strikes.
This becomes challenging, though, with an aggressive shock like what we saw in December. While we like to be opportunistic, it’s always important as a portfolio manager to stay true to your approach and your risk profile. Everyone likes higher returns, but the core investor in the Market Neutral Income Fund is risk-averse. In fact, many people rely on it as an alternative to traditional or core fixed income.
So, while we are looking to be opportunistic, at the end of the day we need to make sure that first and foremost we focus on preservation of capital. Our goal is to capitalize on the volatility, we just need to make sure we do it responsibly with one eye always focused on the downside tail.
It’s a little different for our Hedged Equity Fund. The core investor, while defensive, is still looking for equity-like returns. In this strategy, we are trying to outperform in down markets but we can be more opportunistic when it comes to monetizing our puts and setting ourselves up for a potential bounce (and see CIHEX Beats Back 3 Equity Market Drawdowns to Finish 2018 Positive).
Q. All things considered, are you satisfied with how the funds held up during the “shock”?
A. Yes. For Market Neutral Income, we prefer to be closer to flat in down periods. But realistically, flat would have been difficult to achieve in December, given that there is some equity sensitivity in the hedged equity sleeve.
We like that sensitivity—we think it blends well with our convertible arbitrage strategy and provides us the opportunity to capture some extra return during rising equity markets. Our challenge is to make sure that our equity sensitivity is non-linear—by that I mean that our response to a decline in the equity market is not proportional to that decline.
We like the upside but we don’t want too much downside equity participation. That’s why we layer in puts and put spreads and have an opportunistic—as opposed to formulaic—approach.
In a market move like what we saw in December we know there will be some participation in the initial sell-off. But we can sleep easier at night knowing that the fund’s additional put protection will kick in and our participation will decrease should the equity market fall further—and before we get to levels we aren’t comfortable with.
Our Hedged Equity strategy is a similar approach. But since it’s positioned as a defensive equity fund, it can be a bit more opportunistic and rebalance quicker.
Q. Dave, what should financial advisors take away from the funds’ performance vis-à-vis other market neutral or options-based funds?
A. Some of the funds’ peers, and occasionally the categories as a whole, can tend to be simply long leaning or short leaning. While they may perform well in one-directional markets, they don’t provide the opportunities to reset their market exposures like we attempt to. Rather than focus solely on long or short leaning, we try to position our funds to be both, and the value of a dynamic approach shows in a year like 2018.
We’d obviously like better absolute performance out of the equity and fixed income markets, with equity markets negative and core fixed income flat, but the funds’ positive calendar-year returns for 2018 show what our opportunistic approach can provide.
Advisors, for more information, contact your Calamos Investment Consultant at 888-571-2567 or [email protected].
Calamos is the fourth largest alternatives manager by assets under management and #1 in alternative flows for 2018 (Morningstar data, 12/31/18).
Before investing carefully consider the fund’s investment objectives, risks, charges and expenses. Please see the prospectus and summary prospectus containing this and other information which can be obtained by calling 1-800-582-6959. Read it carefully before investing.
Alternative investments may not be suitable for all investors.
An investment in the Fund(s) is subject to risks, and you could lose money on your investment in the Fund(s). There can be no assurance that the Fund(s) will achieve its investment objective. Your investment in the Fund(s) is not a deposit in a bank and is not insured or guaranteed by the Federal Deposit Insurance Corporation (FDIC) or any other government agency. The risks associated with an investment in the Fund(s) can increase during times of significant market volatility. The Fund(s) also has specific principal risks, which are described below. More detailed information regarding these risks can be found in the Fund’s prospectus.
Data as of 12/31/18
Data as of 12/31/18
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