Volatility Managed Index Portfolio | 11.1% CAGR, -19.6% MDD | Balanced

Welcome to this edition of Avalon QuantBrief, where we dissect the mechanics of the Volatility Managed Index Portfolio, a strategy inspired by classic academic volatility-managed frameworks. By dynamically adjusting exposure based on market turbulence, this systematic approach aims to capture upside while mitigating catastrophic drawdowns. In this brief, we break down the rules, analyze the historical performance, and deliver our final verdict on this balanced strategy.

Backtest Summary (2017–present)

📈 CAGR: 11.1%
📉 Max Drawdown: -19.6%
⚡ Sharpe Ratio: 0.78
💰 Total Return: 186.0%
🎯 Universe: TQQQ, UPRO, SOXL, TLT, GLD, SHY

Balanced: Return Versus Risk

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Our backtest of the Volatility Managed Index Portfolio yielded an 11.1 percent CAGR, but this return came alongside a notable 19.6 percent maximum drawdown, leading to a balanced risk verdict. To understand if this strategy fits your portfolio, we must look beyond the headline numbers to examine its exact rules, return path, and historical loss periods. This systematic breakdown will help you evaluate whether the return profile justifies the drawdown risk in practical application.

The Core Volatility Framework

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The foundation of this strategy relies on dynamically scaling asset exposure based on prevailing market volatility using a diverse universe of TQQQ, UPRO, SOXL, TLT, GLD, and SHY with weekly rebalancing. Risk assets are only held when the SPY trades above its 200-day Simple Moving Average and the Volatility of Volatility Index, or VVIX, remains below its rolling 80th percentile. If these conditions fail, the portfolio immediately shifts into defensive-scaling mode to preserve capital.

Enhancing the Classic Model

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To optimize the classic framework, we developed an adapted version featuring three key upgrades: vol-of-vol gating to aggressively cut exposure when the VVIX exceeds its 80th percentile, and asymmetric volatility scaling to reduce risk rapidly when 5-day volatility exceeds 21-day volatility while scaling back up slowly. Additionally, we employ concentrated leveraged selection, dynamically targeting the single strongest performing leveraged ETF among TQQQ, UPRO, and SOXL during low-volatility regimes. This combination of tight risk gates and selective leverage aims to maximize efficiency.

Verified Backtest Results

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The verified historical simulation of this enhanced strategy produced an 11.1 percent CAGR, a 186.0 percent total return, and a Sharpe ratio of 0.78, accompanied by a 19.6 percent maximum drawdown. It is crucial to remember that these are backtested results rather than a guarantee of future performance. When assessing the viability of this strategy, the depth and duration of the drawdown are just as critical to consider as the annualized return.

Profit And Loss Regimes

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Looking closely at the equity curve reveals that returns arrive unevenly, with the strategy recording 9 positive years and 2 negative years over the testing period. Evaluating the strategy's real-world viability requires analyzing the depth of these drawdowns and the time required to recover, rather than relying solely on the average CAGR. Understanding these specific losing periods is essential for determining if an investor can psychologically stick to the strategy during dry spells.

Verdict: Balanced

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Ultimately, our verdict on the Volatility Managed Index Portfolio is balanced; while the systematic rules are robust, the 19.6 percent maximum drawdown represents a significant hurdle. Any live implementation would require careful position sizing and risk management to withstand these historical loss periods. Treat these findings strictly as research, compare them against alternative models, and never assume past performance will replicate in future market regimes.

⚠️ Not financial advice. This is for educational purposes only. Always do your own research before investing.

📄 Original paper: Volatility Managed Portfolios (Journal of Finance, 2017)

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