Volatility as an asset class - A valuable portfolio diversifier in volatile times?

This article examines the feasibility of using volatility as an asset class to diversify equity portfolios. Especially exchange-traded volatility products targeted at retail investors promise convenient but effective equity hedging. This study looks under the surface of these seemingly simple products, and backtests them in extensive portfolio diversification studies. We apply a wide range of test settings, including different volatility weights, product maturities, time periods, rebalancing patterns, and dynamic allocation strategies while adopting the perspective of U.S. equity investors over the volatile period from 2006 to 2011. We find that volatility exposures of up to 10%, implemented through mid-term volatility products or with a straightforward dynamic allocation strategy based on detecting trends in implied volatility, would have benefited equity portfolios in most scenarios.