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If this is the best humans can do, then bring on the robots

Reuters/Hamad I Mohammed
Safer bet.
  • John Detrixhe
By John Detrixhe

Future of finance reporter

Published This article is more than 2 years old.

For months—years, even—the stock market was unusually calm. It rose steadily and predictably, which made some people antsy. To boost returns, they figured out that you could bet on the boringness of stocks. Billions of dollars poured into two popular investments that tracked the inverse of the VIX volatility index—that is, their returns rose as volatility fell.

This bet made quite a lot of money for quite a long time. Ordinary investors crowded in on the trade after hearing about it from a friend (or Uber driver), while others were told to buy the exotic exchange-traded products by their financial advisors.

You can guess what happened next. This month, the market’s worst week in years was followed by one of its best, with share prices whipping around wildly from one day to the next. Inverse-volatility funds lost nearly everything. Credit Suisse liquidated its suddenly near-worthless security, which had $1.9 billion under management before the mayhem, much of it held by retail investors.

These securities are designed for the pros, often as a way to hedge derivatives portfolios. They shouldn’t be held for more than a day or two, and certainly not in retirement accounts. For anyone who reads the prospectus, this was made clear: Credit Suisse said the “long term expected value” of its exchange-traded note was “zero.” (It pays to read the fine print, after all.)

Despite the carnage, this week investors came back for more, with net inflows to volatility-linked investments worth millions.

If people keep piling into funds they don’t understand, or rely on advisors without doing background checks, then maybe it’s time to let robots take over. Robo-advisory service Scalable Capital, for example, says volatility-linked products wouldn’t even qualify for their automated portfolios because they aren’t “investment assets.” Algorithms don’t exaggerate potential returns to win a new client, and they aren’t ashamed to rely on boring but effective financial strategies. And they don’t take investment advice from Uber drivers.

This was published in the weekend edition of the Quartz Daily Brief, our news summary that’s tailored for morning delivery in Asia, Europe and Africa, or the Americas. Sign up for it here.

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