Beyond Volatility Timing: The Hidden Power of Target Timing in Portfolio Management

Recent papers argue that volatility management performs poorly in real time. Decomposing the abnormal return of volatility-managed portfolios, we find that a negative target timing effect contributes to explaining the observed underperformance. Target volatility calibrated by previous studies positively co-moves with factor volatility in real time. During factor crashes, the increase of target volatility impedes deleveraging factor exposure to profit from a weak risk–return trade-off, effectuating a negative target timing that reduces the benefits from volatility timing. We propose an improved volatility management strategy that introduces a positive target timing effect. For a comprehensive set of 205 common risk factors and trading anomalies, the improved strategy has a significant advantage over plain volatility management by promoting substantial increases in the average returns and Sharpe ratios. The profitability of the improved strategy is robust to leverage constraint and transaction costs.