This is a matrix that outlines the correlations between the various asset classes between 2004-06 and 2007-08 in parentheses. Note the increase in correlation between 2007-08 relative to 2004-06. It’s a clear indicator there was much less of a diversification benefit in ‘07-’08 than people believed they were getting. Plus, the diversification wasn’t there at the time investors needed it the most. Only Managed Futures had a negative correlation with Equities in ‘07-’08, which is what you look for in diversification.

While all assets had positive correlations, it wasn’t a 1:1 relationship. I think most of that difference is a function of relative liquidity of the asset classes to each other.

1

A great example of what I call a “quant fallacy” – correlations between assets are constants. Correlations can be treated as constants for a short timeframe given that there’s little volatility in the market. Otherwise, it’s a variable to be measured/monitored on an ongoing basis.

2

This slide shows why buying VIX futures doesn’t work. Being long on volatility without recognizing its mean-reversion properties is not a money-making strategy. Over the long-term, you’ll lose as much as you gain because of this simple fact regarding volatility. To borrow that line from the Ronco Rotisserie Roaster (c’mon, you know the one), you just don’t “set it and forget it.” You need an active approach.

3

A few points:

•VIX Futures standard deviation is highest among asset classes here & along with Real Estate and Private Equity, VIX Futures had the lowest % of Up days •However, their returns were third behind Managed Futures & Bonds. Granted, those two asset classes had some better risk characteristics, but this is another way of underscoring that VIX assets can give true diversification benefits, but due to volatility’s mean-reverting properties, standard deviation will be higher. •Note the return in VIX Futures for the much shorter window from 8/2008 – 12/2008. Standard deviation actually fell while Equity, Private Equity, Real Estate, & High Yield Bonds saw their standard deviations increase.

4

In the world of portfolio management, this is a well-worn figure – the efficient frontier. The goal, of course, is to find build a portfolio that lies at a point anywhere on the frontier. Outside the frontier is not possible, but you definitely don’t want to be inside the frontier, either. That’s a sign that your portfolio is taking on excessive risk or achieving sub-optimal returns. But in most cases both are probably happening.

Note the risk/return profile of the 100% Stock/Bond/Alternative portfolio. Compare that to a 75% Stock/Bond/Alternative, 25% VIX Futures portfolio. For a 15% increase in standard deviation/risk, you get almost a 5-fold increase in return. Seems like a good trade-off to me.

5

Here’s another efficient frontier, this time the VIX exposure comes through at-the- money (ATM) VIX calls. Risk/return is improved, but not enough bang for my buck at 2.5% ATM VIX calls. 1% is nice, because volatility of returns are reduced as well as a 100 bp gain in return.

An active approach with this asset class is key.

6

Here, the VIX calls are out-of-the-money by 25% (so the calls are still long volatility an additional 25% to the upside). In episodes of extreme fear and panic, the force/violence of the move is just as important as the direction – possibly more so. To see that a 2.5% weighting doubles volatility but annualized return increases 10% (for the entire 3/2006-12/2008 timeframe, return increased nearly 29%), it makes sense to have a VIX weighting in your portfolio. But, it has to be actively managed for maximum benefit.

7