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Vincent D's List: Protection against tail risks
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Market volatility and global uncertainties are driving investor demand further into gold and volatility-linked products as a means of hedging and managing downside risk, and boosting structured product payouts into the bargain
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What these products try to do is provide the investor with exposure to implied volatility while keeping the roll cost to a minimum. They are popular because it is a way to diversify your holding.
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Morgan Stanley has launched a series of dynamic indexes that limit negative carry by using short volatility overlays so that investors with long equity exposures can hedge their equity positions during periods of market turbulence
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The VolNet Hedge index uses net long exposure to reap the diversification benefits of volatility while minimising negative carry by using a short volatility overlay, whereas the VolNet Alpha index dynamically extracts volatility premiums with a long variance overlay.
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Access to volatility is a relatively new innovation, and the rise in popularity in the asset class is attributable in large part to the development of exchange-traded products that offer relatively cheap and efficient exposure.
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As investors are increasingly looking for ways to access equity market volatility, this ETN offers them exposure while aiming to reduce the roll costs furing calm markets and potentially providing enhanced beta to the VIX Index during more volatile periods,
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We wanted to build something replicable, transparent and very liquid that would be the best possible hedge for equity volatility
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Other indices try to enhance your returns through strategies embedded in black boxes. This product does what it says on the box – it’s the best way to be long volatility in a liquid fashion
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Oct 11, 11
Credit Suisse Launches New FX Volatility Indices
London, February 7, 2011 Credit Suisse today launched two new investable volatility indices which are designed to provide a cost-effective way to gain exposure to currency volatility. The Credit Suisse Advanced Volatility Index series – FX (CSAVI-FX) - has the characteristics of a hedge against sharp declines in traditional risk assets and is intended to offer investors protection during periods of high market volatility.
Credit Suisse is now offering the following indices:
- The CSAVI-FX Opportunistic
- The CSAVI-FX Opportunistic Long Only
The indices represent the returns from strategies developed by Credit Suisse’s Algo Strategy and Modelling team which help investors analyse currency movements and volatility levels before entering into volatility trades. The main Opportunistic index represents returns on a trading strategy which can go long and short volatility while the long-only index reflects values from a strategy that is restricted to buying volatility positions.
The strategies monitor 12 different currency pairs and use a “jump-diffusion” model of exchange rate dynamics to forecast large jumps in exchange rates which push volatility higher. This analysis allows the model to assess more accurately when current implied volatility is over- or underpriced. When making trading decisions, the strategies also take into account the liquidity available in the underlying currency pairs to help maximize returns even if bid-offer spreads are wide.
Credit Suisse will offer clients the ability to easily and simply gain exposure to these indices using total return swaps. The ability to trade this kind of strategy in an index makes the foreign exchange volatility market much more accessible to asset managers who, otherwise, would be unwilling or unable to execute, monitor and manage a wide range of over-the-counter FX volatility market trades.
“As CSAVI does not incur the hedging premium associated with direct hedges in the equity options market, we believe it offers the right balance of cost efficiency and general tail risk hedging characteristics for the current environment,” said Chiente Hsu, Head of Global Algo Strategy and Modelling at Credit Suisse.
Enquiries
Adam Bradbery (Europe), Corporate Communications, Credit Suisse, Tel. +44 207 888 6744, adam.bradbery@credit-suisse.com
Steven Vames (U.S.), Corporate Communications, Credit Suisse, Tel. +1 212 325 0932, steven.vames@credit-suisse.com -
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Unsurprisingly, with memories of the financial crisis still fresh, many investors have looked to insulate their portfolios against the bleaker scenarios by investing in tail-risk protection. The financial services industry is happy to oblige, offering everything from exchange traded funds based on volatility to tail-risk funds from both mainstream and hedge fund managers.
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For example, a 2010 research paper, A constant volatility framework for managing tail risk , by Alexandre Hocquard, Sunny Ng and Nicolas Papageorgiou of investment consultancy Brockhouse Cooper and HEC Montreal business school, suggests adjusting portfolio exposure according to varying levels of volatility – reducing exposure when volatility is high and vice versa.
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Nov 07, 11
Some banks have started to sell tail-risk products. Deutsche Bank has created the ELVIS index, which generates returns when stockmarket volatility increases.
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Some banks have started to sell tail-risk products. Deutsche Bank has created the ELVIS index, which generates returns when stockmarket volatility increases
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PIMCO now oversees around $30 billion in tail-risk products, mostly in separate accounts. Other funds have also seen inflows. Take, for example, Universa Investments, a tail fund advised by Nassim Taleb, author of “The Black Swan”, which has grown from $300m in 2007 to around $6 billion today.
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Nov 07, 11
nvestors are increasingly allocating to tail risk hedge funds as concerns continue to mount over the eurozone’s health and the US recovery.
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Such funds, which include Arrowgrass, Bennelong and 36 South, have witnessed increases in assets over the last two months, according to a recent JP Morgan survey. Year-to-Date (YTD) returns of these hedge funds have also been positive with 36 South posting YTD returns of 93%, for example.
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Mar 19, 12
Hille has used options on volatility and variance swaps to hedge in the past – and did so, luckily, before Japan’s natural disasters a year ago.
But volatility “rose, then came back just as quickly, to levels lower than where they were before the crisis”.
“Timing is therefore crucial, otherwise you just lose out,” Hille says. “If you are long volatility then you are massively short theta, and when you have a bad event like Fukushima, the markets can gap and there is massive payout.
“Or you can have situations where nothing happens in the markets – this often takes long periods of time – and you pay a huge carry on the position. When it is calm, you do tend to lose on that strategy.”
Hille’s funds profited from the equity gains in January and February. But the market gains were not broad enough to give him full confidence recovery is essentially sustainable.
“In the Dax, the Nasdaq and S&P 500, five to ten names drove more than 50% of index performance. That is not healthy, and not broad growth. You could be 100% long stocks, and still have had close to zero performance in January.”
He adds that the “huge liquidity buffers in the market” – for example, Mario Draghi’s €1trn long-term refinancing operation – can actually magnify volatility. Coming into 2012, Hille took a “double barbell” approach in the equity segment of his multi-strategy funds.
On the one side was a defensive carry portfolio (high dividend yield growth stocks and exporters). On the other side was a high beta section, investing into baskets of ten to 15 companies from typically high beta sectors such as materials and financials.
The former has beta of about 0.75. The latter’s beta is closer to two, though in December to beginning of February, it made 37%.
“If markets fall, you lose the premium you pay on the high beta basket. On the upside it saves you, in that you participate in at least 75% [of the rise]. You can only perform adequately if you have a barbell.”
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