In the investment world there has been an arms race going on for years: seeking alpha. Active managers seek alpha and investors seek managers with alpha. Quants seek alpha models and try to distinguish themselves by identifying new sources of alpha.
Lately more and more investors say that what we used to think of as alphas are really betas. Some of my former colleagues at Westpeak wrote a book on it, called ActiveBeta.
In the early 1990s Fisher Black and Robert Litterman published an equilibrium-consistent approach to asset allocation that permitted the investor to express views about asset returns and find an appropriate optimal portfolio. Jay Walters has a wonderfully helpful website on it, BlackLitterman.org.
Why There Isn’t There a Black-Litterman Model for Investor Views on Volatility
Market equilibrium links market weights, volatilities, and returns. Black-Litterman reveals alternative weights by allowing for variation in the returns while holding volatilities unchanged.
Unchanged.
If you want to change the volatility assumptions, this model doesn’t offer much guidance.
How Do You Tilt Based on Volatility Views?
PIMCO has popularized the phrase “Risk On/Risk Off” and now we have ETNs offered by UBS that purport to give you exposure to whether risk is “on” or “off.”
I take a more granular view of risk being “on” or “off” in terms of specific asset classes. Rather than shift my entire portfolio according to whether risk is “on,” I would rather assess the asset classes one by one and shift their weights according to whether they are likely to be in favor. This doesn’t require an elaborate model, and it is easily within the grasp of any interested investor.