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Volatility: Fractional Markets' Wild Card

Volatility: Fractional Markets' Wild Card
October 22, 2021
Dylan Dittrich

Volatility. For fractional investors, it’s like a partygoer that presents varying probability of ruining the get-together entirely or taking it to unforeseen highs.

“I think I like him,” says one fractional party guest. “He keeps things interesting.”

“No way, nobody wants to come to a party he’s at,” says another.

We didn’t invite him. Should we kick him out? Can we kick him out? When he acts up, do we go with the flow? Steer into the skid? Leave?

A year ago, daily trading of fractional assets was but a distant possibility. Today, two marketplaces, Otis and Collectable, offer daily trading of hundreds of assets collectively, with that total growing on a weekly basis.

We’ve come so far. Great, right?

Yes, of course. But…

….volatility. Yup, volatility just strolled onto the dance floor with one objective: get (inappropriately?) wild.

While undoubtedly the fractional markets have both matured and grown dramatically over the course of a year, liquidity is still limited by most conventional measures. So, the availability of daily trading, while welcome, introduces challenges, namely: volatility.

When liquidity is thin, meaning that there are either few buyers of an asset, few sellers of an asset, or both, the magnitude of price movement required to execute a transaction can increase quickly. All it takes is one motivated (or ill-informed) buyer or seller to drive a price – even if just temporarily – to levels wildly different from the prior day’s.

Many view such a consequence as a negative, arguing that wild price swings are a deterrent to increased participation, that they muddy the true value of the asset, and that they may also either repel solid buyout offers or encourage less than stellar ones.

Fair arguments.

Traditionally, though, those arguments would matter little to long term holders, who would be largely unconcerned with the day-to-day movements of an asset and principally concerned with whether or not a 5-10 year investment thesis had fundamentally changed. Their occupation with day-to-day movements would arise mainly from the creation of an opportunity to add to positions during unduly negative trading sessions.

But, as we know, these are alternative asset markets, anything but traditional.

In large part, what we’ve said above rings true. And if a long term investor wished to remain blissfully unaware of day-to-day movements, they’re certainly welcome to do so, but they may be roused from their fractional asset hibernation to find that A) their asset has been bought out for lukewarm returns and they didn’t make plans to reinvest B) they’ve missed incredible opportunities to add to their position well below their cost basis or C) others more quickly came to a conclusion about a fundamental thesis change, and liquidity on the buy side of a potential transaction is now barebones.

Regardless of your time horizon, volatility can matter. That doesn’t mean it’s crippling to the entire system, but fractional investors should be aware of it.

And it’s not just volatility for daily trading that has ramifications, though that’s mainly what we’ll discuss here. Rally’s system, where assets go months without trading, often means bigger moves when assets do trade (even if – similarly to private equity and real estate – volatility appears lower because of less frequent marks). And those big moves in either direction, if irrational, can’t be quickly rectified the next day by more rational, opportunistic money. So, when many comic books traded down heavily in the spring, it was instead opportunistic buyout offers that capitalized on weakness. This system does, of course, encourage longer term thinking with these assets – many of which have seen their impressive track records accrued over years and decades, not days and weeks. It can also ensure greater liquidity as the eyes of the platform are collectively focused on three assets rather than one hundred. And isn’t it a lack of liquidity that is truly at the root of the volatility issue?

Still, many prefer the optionality and flexibility of daily liquidity – there are simply pros and cons to each system.

So, which waters are the choppiest? And where can shareholders find relative calm?

If we look across the three marketplaces with trading – Otis, Rally, and Collectable – and analyze only those assets that have traded for more than a month, we find that the average daily volatility is highest in the short-lived track record of NFTs, and perhaps it will surprise few to learn that video games are second. If that did surprise you, bear in mind that volatility is dual-directional, so those assets that have performed quite well can indeed have high volatility.

Least volatile are cars, wine, and books – this makes sense because all three of these asset classes currently trade only on Rally, and Rally’s daily volatility statistics are organically muted by the infrequency with which they trade.

If we exclude Rally assets due to this difference in trading system, we find that NFTs and video games remain most volatile, along with luxury items (the Birkin on Otis) and comic books. Art and trading card games are the least volatile, while sports cards, memorabilia, and sneakers all cluster into a similar range. If you view most charts on Otis for art assets, this makes sense, as many of these assets have stagnated at the same price for extended periods.

We can drill down further to look at how volatile individual assets have been over their respective trading periods. Six of the top ten most volatile assets currently trading are on Otis, two are (against all odds) on Rally, and two are on Collectable.

The inclusion of the first three on Otis may be derived from their relatively short track records: the Grimes NFT Collection, Mike Tyson’s Punch-Out, and Special Marvel Edition #15. We’ve measured the volatility for the duration of each asset’s trading history. Each of those assets began trading in early September, and though they may not stand the test of time at the top of these rankings, their paths to date have certainly been turbulent. In the case of NFTs and video games in particular, the categories are relatively nascent and further volatility may indeed be the expectation.

Both Zelda assets are influenced by monstrous one day gains. The Ocarina of Time on Rally gained 326% on August 9th, while Zelda II on Otis actually gained 350% on the exact same day, rising from $10 to $45 before plummeting back towards $30 days later.

If we switch to look at the least volatile assets, we have little choice but to exclude Rally assets. Otherwise, the 66 (!) least volatile assets would all have addresses on Rally Road. Again, in no way does this mean that you can expect stability from these assets when they do trade – rather, the stability of their prices during the 90-120 days between trading windows naturally weighs on the calculation of deviation of daily returns.

The average performance of the ten least volatile assets is quite muted at -5%. Only one of the ten assets, the 1986 Fleer Basketball Sealed Box on Collectable, is up double digits. Six of the ten are down since inception.

Clearly, very large one-day swings, even if isolated events, can influence this measure of volatility. So we crunched the numbers to frame the conversation in other ways as well. For example, which assets have remained flat (zero percent daily return) on the largest percentage of days since they began trading? Here, you can see the relative stability of art reflected, with the asset class comprising six of the ten assets with the largest percentage of zero return trading days. It’s additionally fun to see Kawhi’s electric personality carry over to the fractional world, where prices for his rookie basket haven’t moved 89% of days. Of course, remaining flat may not necessarily be a good thing, as it's perhaps demonstrative of weak interest in the asset.

On the flip side, you wouldn’t expect any of the assets below to stay put more than 50% of the time. Among these assets are some of the most discussed, debated, and otherwise culturally interesting: Jordan’s Shattered Backboard sneakers, CryptoPunk 543, NES Super Mario Bros, and Police Car by Banksy among others. You’ll also find key Hobby names like Mantle, Luka, and Mahomes.

Flat returns aren’t necessarily the most interesting, so we examined which assets least and most frequently moved more than 5% in either direction. In terms of least frequency, art suddenly doesn’t look quite as boring with just three representatives instead of six; while many of those assets are flat quite often, when they do move, it tends to be more sizable. Interestingly, the athletes that appear here are largely from vintage eras – Mays, Ruth, Robinson, Banks. This intuitively makes sense: their careers have long since ended, the track records for their assets are long, and therefore the volatility should be more muted. It would be more rare that investors would wake up and impetuously move the asset’s value by large percentages.

All ten of the assets that most frequently move more than 5% in either direction are on Otis. However, seven have only recently begun trading; so they've only traded during the instant trading era. Still, the large representation from video games is not a surprise, nor is the appearance of the CryptoPunk or Special Marvel Edition #15, given the timely release of the Shang-Chi movie.

What can we learn from this?

First, it remains extremely early. The perfect trading system doesn’t exist yet because the perfect trading system can’t exist yet. The liquidity simply isn’t there. That being the case, there will be pros and cons to both a daily trading system and one with less frequent trading. More participants arrive on the fractional scene each day, and slowly but surely – particularly as newcomers seek assets they missed at IPO – liquidity will improve.

Until then, however, fractional investors must trade with heightened caution; diligence should never stop after the IPO. Just because an asset’s last trade was at $100 doesn’t mean it’s worth $100 to you or even to the next buyer; it was just worth $100 to that buyer. Conversely, just because an asset that you bought for $10 last traded at $4 doesn’t necessarily mean it’s a failed investment that should be abandoned at the earliest opportunity. Volatility will persist – both daily and during scheduled trading windows – and unless an investor’s core thesis has changed, they will have to be prepared to stomach the peaks and, more pressingly, the valleys that come with the territory.

That being said, while there have been moments of broad trepidation, the environment for the assets traded fractionally has been quite favorable on the whole. So those assets that are less volatile – where there isn’t much movement – are simply the subject of tepid interest. There has been muted trading activity in these assets, and it tends to be more the variety of select IPO buyers calling it quits at a mild loss.

On the flip side, high volatility doesn’t necessarily mean strong performance – though it has in many cases to date. The average return of the top ten most volatile trading assets is 150%. There are a couple of very large losers in there, but for the moment, high volatility has been more likely to correspond with outsized returns than with heavy loss – simply a product of the moment.

Of course, high volatility on the ascent creates opportunity for further volatility of the less fun flavor on the way down (as was the case with Zelda II). Proceed with caution. As we pointed out recently, buying the dip has better favored investors than chasing momentum.

Volatility need not be considered a fractional investor enemy. Nor should it be counted on as a friend. Most accurately, it’s an unreliable acquaintance that will find its way to the party one way or another. Don’t count on it to do you any favors, to be an unwavering bastion of honesty and truth, or to sit quietly on the sidelines. You haven’t known it that long!

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Disclaimer: You understand that by reading Altan Insights, you are not receiving financial advice. No content published here constitutes a recommendation that any particular security, transaction, or investment strategy is suitable for any specific person. You further understand that the author(s) are not advising you personally concerning the nature, potential, value or suitability of any particular security, transaction, or investment strategy. You alone are solely responsible for determining whether an investment, security or strategy, or any other product or service, is appropriate or suitable for you based on your investment objectives and personal financial situation. Please speak with a financial advisor to understand if the risks inherent in trading are appropriate for you. Trade at your own risk.

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