Coping with chaos

Our Multi Asset team focusses on how option structures can efficiently allow participation in an upside market move while protecting investments.

Sep 4, 2017 | Dave Jubb and Danielle Singer

If we look at the movement of financial market prices, we can see clear evidence that it exhibits chaotic characteristics. However, complex systems – like financial markets – do not feel perpetually chaotic. Indeed, patterns can be observed whereby longer-term regimes seem to exist prior to those that change unpredictably. In mathematics, this observation is known as a ‘strange attractor’; it describes how systems can persist in a specific state for some time before acting unpredictably again.

Even when investors evaluate a market’s deviation from long-term price or volatility averages, or analyse the prevalence of macroeconomic risks, and are led to believe that there is a regime shift on the horizon, it is impossible to accurately time this with consistency. If your investment horizon is long enough, this may not matter, but for many investors with specific liabilities or investment goals, the impact of these unpredictable cycles can be devastating.

In the investment world, coping with chaos can therefore mean adding value by investing to capture the upside of positive market returns, and also by giving due consideration to protecting during market drawdowns. We believe that this value comes from structuring an investment using the best implementation route – one that maximises an asymmetric return payoff profile after costs have been taken into account.

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