Josh Sheluk outlines the merits of moderating volatility in portfolios, argues options strategies aren't worth their trade-offs
Josh Sheluk sees clear merit in moderating short-term volatility in client portfolios. The Portfolio Manager & CIO at Verecan sees both a mathematical and a behavioural benefit for clients in working to offset volatility. Softening the peaks and troughs of the market can help, mathematically, in preventing drawdowns at a low point in the portfolio and producing a more consistent returns stream. That consistent returns stream can also help moderate clients’ human reaction to fear-inducing market events. If they see their portfolios have taken fewer hits, they’re more likely to stay invested an participate in upside. Where Sheluk diverges from much of the industry’s conventional wisdom is that he believes advisors don’t need a dedicated volatility-moderating product to achieve this result.
Sheluk notes that a large number of ETF strategies have been launched on the Canadian market in recent years promising to offset volatility. Those could be balanced funds, that offer an all-in-one 60/40 equity/bond portfolio. Those could also be options ETFs, which write covered call or put options to monetize volatility and pay income yields. There are also a new set of explicitly low-vol ETFs as well as buffer ETFs that use complex management strategies to soften markets’ inherent volatility. These products exist on a wide spectrum, but Sheluk’s view is that few of these products offer more benefit for clients long-term than ordinary diversification, especially when looked at net of fees.
“To specifically talk about covered call strategies, because they are so prominent these days, I don't think that this really achieves any of the objectives that clients have or that we have as advisors. They may very, very, very slightly mitigate volatility, but I actually did a deep dive on covered call strategies a couple weeks ago for our internal team and found that there's some volatility mitigation, but very, very little and not something that's meaningful or impactful in any sort of way,” Sheluk says. “The proponents of covered call strategies are going to say, it's generating a consistent return stream via the income that you're getting. But I would push back on that and say that if you just look at the past results from these products that have been around for five or 10 years now, they're consistently underperforming from a return perspective.”
Looking across the gamut of volatility-managing investment products, Sheluk notes some viability in that balanced fund approach. He notes that advisors can achieve a similar structure, but with the right asset mix of equities, fixed income, and cash they should be able to moderate sequence of returns risk and most of the behavioural issues that could come with a drawdown. Conversely, he describes the bucket of covered call option ETFs, buffer ETFs, and low-vol ETFs as “very poor products for poorly designed portfolios.”
Even those products that Sheluk accepts achieve some of their mandate in moderating volatility come with higher costs and complexity than he believes to be worthwhile. Even the addition of alternative asset classes like gold, private equity, or private credit are, in his view, less valuable from a long-term returns perspective. He argues that the claims of volatility mitigation made in the marketing of many alternative assets is more a function of their lower pricing frequency than their actual value day-to-day. He believes non-correlation can have value to offset volatility, provided those non-correlated assets are assessed based on the kind of volatility they would introduce into a portfolio.
Many proponents of volatility management strategies like covered call ETFs or low vol ETFs might argue that their active management approach allows them to both capture higher options premiums from market volatility and remain cognizant of total returns and upside. Sheluk cites his own analysis to say, however, that over a ten-year period, every covered call strategy with that time frame has underperformed. Moreover, he argues that claims of active management driving value are effectively arguments that someone can time the market, something he is skepitcal about at baseline.
Despite his own objections, covered call and other volatility managing ETF strategies have become incredibly popular in Canada. While some might argue this stems from the 60/40 bear market in 2022, Sheluk notes that those circumstances were so specific as to not weigh on most investors’ future expectations. Instead he notes that Canadian investors have a real infatuation with yield, and covered call strategies at least serve to satisfy that yearning.
For advisors confronted with a dizzying array of choices and marketing materials that highlight one or other ETF as the solution to all the volatility today and in the future, Sheluk argues for a simple, logical approach to any product: think about trade-offs.
“I just inherently believe that I’m not getting reduced volatility without giving something up,” Sheluk says. “I understand and believe in risk-return trade-offs in the market, so anytime somebody markets something to me that will either enhance my returns or reduce my volatility, my immediate question is ‘what am I giving up for that?’ There’s been a lot of research on volatility mitigating strategies and it consistently come back with the finding that you might get slightly less volatility but you’re giving something up on the upside.”
