Austrian investors on the hunt for the perfect volatility fund
Volatility products are gaining popularity, yet fund selectors in Austria are struggling to decide which ones to use from the growing choice of absolute return and hedging strategies.
Volatility products are gaining popularity, yet fund selectors in Austria are struggling to decide which ones to use from the growing choice of absolute return and hedging strategies.
When volatility rears its ugly head, diversification is in short supply. The villain itself could provide relief as the launch of volatility products shows a growing interest in this niche of alternative products.
When stock markets go down, volatility shoots through the roof - as the episodes from October 1987 to September 2008 and April of this year have shown.
Even as fund selectors in Austria echo the merit of these strategies in theory, they seem reluctant to plunge into the new asset class of volatility.
"Volatility funds are interesting concepts, as we like to have negative correlation to equities in tough times. Yet many products do not deliver what we ask for," claims Ingo Kröll (pictured), head of the investment office at LGT.
A hidden market
Daniel Feix, selector at C-Quadrat, voices other concerns: the problems for many products arise in markets that go sideways as rolling losses serve as an insurance premium to be paid for investing in a volatility strategy.
Florian Gröschl, from Vienna consultant Absolute Return Consulting, sees a lot of interest in, but fewer transactions into, volatility products.
He says: "Volatility is a new asset class, and selectors still have to figure out where to put these strategies within their asset allocation."
He sees the simplicity of a specific product as a convincing argument, as portfolio managers could withdraw from options or other derivatives.
But even being a "good diversifier", volatility is hard to grasp for many selectors, says Gröschl. "The wide product range scares off people, because different products can behave very differently. People often tap these markets with the wrong expectations."
Guy Hurley knows what investors in volatility complain about. At a recent conference in Vienna, organized by the VAI (the Association of Alternative Investments), the co-founder of investment firm HCM warned about the "bleed" associated with investing in volatility.
Buying volatility comes with huge costs as realised volatility is generally lower than implied volatility. Making things worse, the futures curve of a classic volatility index such as the Volatility Index (VIX) on the stocks of the US index S&P 500 is generally in contango. Rolling across the curve thus leads to losses for investors.
"Buying volatility is extremely difficult. Owning volatility costs a fortune," concluded Hurley. Fund managers need to mitigate the bleed by employing active strategies.
However, managing such losses often means losing the unique proposition of volatility products: offering a hedge in bad times.
As many products need to short contracts at the short end of the curve to reduce the losses rolling down the curve, they might not benefit if volatility spikes. On the contrary, they could lose money.
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