Volatility risk premium extraction strategies can be used to improve the investment outcome in a traditional balanced fund, according to research from Alexson Lee, Protected Growth Strategies Portfolio Manager, Global Fixed Income.
 
Volatility risk premium is the compensation demanded by investors for bearing the financial risks associated with the variability in market volatility.  
 
At AMP Capital’s recent bi-annual Global Fixed Income Research Forum, Lee demonstrated that the extraction of equity volatility risk premium, has a compelling risk-reward trade-off, is imperfectly correlated to equities and has smaller drawdowns compared to equities. 
 
Volatility risk premium can be a stand-alone income enhancement strategy and/or a suitable replacement for physical equity in a balanced fund. 
 
‘Volatility itself is volatile,’ says Lee, ‘but historical studies show that a persistent premium exists for volatility risk.’ 
 
While investors tend to be familiar with risk premium concepts related to equity, credit and liquidity, the concept of volatility risk premium tends to be less acknowledged. However, investors are increasingly regarding volatility as a separate asset class.

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