Volatile summer feeds the appetite for fear funds


Investors are beginning to see volatility as something that can be exploited, rather than feared, writes Lukas Sustala.

Investors are beginning to see volatility as something that can be exploited, rather than feared, writes Lukas Sustala.

Investors had a tough summer. No asset allocation shielded them from massive losses, as various risky assets slumped in unison. One of the few things exceptions was volatility.

The ‘fear index', the volatility index VIX, which measures the implied volatility of options on the S&P 500 index, doubled in six weeks, reaching levels above 40.

The European equivalents, the VDax and VStoxx, rose to their highest levels since early 2009.

Asset management firms are putting out new volatility products for eager clients, who increasingly think of volatility as an asset class, rather than as a risk.

An investment in ‘fear' should offer some diversification as volatility tends to rise in rough market environments.

Demand for these products has been strong recently. Futures, options and exchange-traded notes (ETNs) on the Vix marked record levels in August, according to the Chicago Board Options Exchange.

Newedge, the prime brokerage group, says volatility strategies in the hedge fund universe are one of only two categories in positive territory year to date.

Yet August was not a good month for many active funds, as the Newedge Volatility Trading index fell by 3.48%, signalling that many funds have bet on declining volatility going into August.

Gilbert Keskin, co-head for volatility, arbitrage and convertible bonds at Amundi and responsible for the flagship strategies in the market, with €6.5bn invested, says: "You have to be an active manager in volatility."

This might mean drawdowns, even when volatility is high. But over the longer term this strategy should pay off, Keskin says.

The directional Amundi strategies focus on one-year implied volatility, selling volatility at times of crisis and buying it as markets price in calm.

Since the beginning of the credit crisis in August 2007 the directional Absolute Volatility Euro Equities fund has returned roughly 50% for investors.

This is a completely different return structure to that of exchange-traded products (ETPs) on volatility indices. As they incur hefty roll costs, the timing for investors is key.

As Keskin puts it: "Investors in passive volatility products need to be active themselves."

A quick look at widely used iPath S&P 500 VIX Short-Term Futures ETN (VXX) proves the point.

Over the past two years the VXX lost nearly 80% of its value, whereas the underlying VIX is up 60%.