Managed portfolios that take less risk when volatility is high produce large, positive alphas and increase factor Sharpe ratios by substantial amounts. We document this fact for the market, value, momentum, profitability, return on equity, and investment factors in equities, as well as the currency carry trade. Our portfolio timing strategies are simple to implement in real time and are contrary to conventional wisdom because volatility tends to be high after the onset of recessions and crises when selling is typically viewed as a mistake. Instead, our strategy earns high average returns while taking less risk in recessions.
We study the portfolio choice implications of these results. We find volatility timing provides large utility gains to a mean variance investor, with increases in lifetime utility around 75%. We then study the problem of a long-horizon investor and show that, perhaps surprisingly, long-horizon investors can benefit from volatility timing even when time variation in volatility is completely driven by discount rate volatility. The facts pose a challenge to equilibrium asset pricing models because they imply that effective risk aversion and the price of risk would have to be low in bad times when volatility is high, and vice versa.