Snapshots loves movie quotes and the following springs to mind this week: “Causality. There is no escape from it. We are forever slaves to it. Our only hope, our only peace, is to understand it, to understand the why.”*


This week the market has been focusing on the spike in volatility and the unwind of retail funds that have been selling volatility. We warned on these products and the triggers that could lead them to unwind in Snapshots in August last year (Inverse VIX and Accelerators).

However, this has diverted the attention of investors from the global monetary policy dynamics which are currently in play and which we have been focused on since last summer. This is the gradual tightening of monetary policy after almost nine years of economic expansion. The Fed, arguably the world’s most important central bank, is in year three of an interest rate hiking cycle and five months into a programme to reduce its holdings of securities that were purchased during its Quantitative Easing (QE) operations.

The Cause

When the world’s central bankers embarked on QE they said that central bank purchases would work through the “portfolio balance channel”. Ex-Fed chair, Bernanke, explicitly described it as pushing investors into holding other riskier assets. As the world’s central banks unwind QE, it would be logical to expect a reverse of some of the effects of QE.

The Effect

In May last year, Snapshots described this unwinding process as “Quantitative Normalisation” and asked “what misallocations of capital will be revealed as this monetary tide starts to creep out?” It is believed that QE suppressed volatility through the portfolio balance channel and the excess liquidity that was created as central banks swapped securities for cash with the private sector. That process is now in reverse. Liquidity is being drained and the assets the central banks purchased are returning to normal positive levels, as is volatility.

We think the VIX fund unwinds are a direct effect of the monetary policy unwinding because capital was misallocated to these products. We also think there are other examples of misallocation of capital:  global house prices, parts of the corporate sector which have aggressively leveraged up and technology stocks that produce no cashflow. There are also many we don’t have the full details of yet. We therefore expect more direct effects from the change in monetary policy dynamics.

Good luck and as ever we are on hand to answer any questions you may have.

*The Matrix Reloaded – 2003 – Warner Brothers Pictures

Asif Godall
Co-Chief Investment Officer