When Volatility Attacked

December’s market volatility was what most investors would expect to see only in a stress test scenario. The VIX jumped from 16 to 36 and back down to 25 all in the span of one month. We talked to Dave O’Donohue, Senior Vice President and Co-Portfolio Manager, about how he and the Calamos Market Neutral Income Fund (CMNIX) and Calamos Hedged Equity Income Fund (CIHEX) team view volatility and how they reacted to the big swings in volatility during December.

Q. Dave, would you step us through what you saw in December?

A. It was a wild month, but we tend to get excited when we have increases in volatility because it can present opportunity for the funds. When there’s too much volatility, though, we need to shift our focus from the opportunity to the risk.

As part of our standard risk management practices, we continually stress-test our portfolios—we run “shocks” for different extreme scenarios. That’s what we had in December: a real-life example of a downside stress test.

In one month’s time the S&P 500 dropped 15%, the VIX more than doubled, and there was a 200-basis point widening of credit spreads from their October tights.

Those are the ingredients for a classic, but extreme, downside shock scenario. Any one of those components is a stressor that can expose weaknesses in a process and in a portfolio, and we saw all three at the same time.