Last month, Soc Gen analyst, Praveen Singh, analyzed evolving cross-asset volatility trends, and boldly went where so many have unsuccessfully gone before. Singh’s warning was that the market is “now entering dangerous volatility regimes.“
The crux of Soc Gen’s argument was mean reversion, notably that the current low level of volatility happens less than 2% of the time for equities. Furthermore, Soc Gen found that when equity volatility has been this low in the past, it went on to rise by 3 points in the subsequent 12 months. This means that volatility is more likely to go up than fall further from current levels… at least in theory.
Portfolio managers, however, are increasingly thinking along the same lines. While it’s rumoured that Brevan Howard will shortly launch a long volatility fund, according to a Bloomberg it appears that there is a surge of interest in launching long volatility funds.
According to Bloomberg “Brevan Howard Asset Management, 36 South Capital Advisors, One River Asset Management and at least three other firms are rolling out new funds designed to protect investors from rising market turbulence.” Former SAC Capital’s, Hamming Rao, opened a volatility fund with a long bias this June, based in Florida.
While buying volatility has been a widowmaker trade in recent years, the fund managers Bloomberg spoken to by Bloomberg couldn’t be more optimistic: Jerry Haworth, the co-founder of 36 South who “tripled investor’s money” during the GFC, launched the Lesidi Fund earlier this month. Haworth commented “This is a multi-decade opportunity to buy volatility’…To increase the appeal of his long-volatility strategy, Haworth focuses on reducing the ‘negative carry,’ or steady bleed of cash, that accompanies calm markets. That’s gotten easier these days as prices for options and other volatility-linked derivatives have fallen.”
In a similar vein, Michael Preiss, a portfolio strategist at $1.9bn Singapore-based Taurus Wealth Advisers argued “The most mispriced asset class in the world is volatility…a bunch of our clients are in discussions with us at the moment about whether to add volatility strategies.”
“The opportunity is right now. One of the biggest fears I have is I miss it.” according to Arun Singhal of Astrid Hill. Singhal expects to launch a volatility fund before year-end with an initial target size between $50 million and $100 million.
The conundrum for investors was perfectly explained a few days ago by the new Nobel laureate in economics, Richard Thaler “We seem to be living in the riskiest moment of our lives, and yet the stock market seems to be napping.” Of course, we can point to all manner of risks which could have major knock-on effects in financial markets, North Korea, Brexit, Peshmerga, several major European banks, China’s credit bubble, etc.
However, since central bank policies are the major reason for our low volatility world, the fact that monetary accommodation is now being (slowly) withdrawn – with ECB expected to join shortly – means that there is finally some prospect for a “regime change” in financial markets. After all, the bubble merchants have generally been raising rates at the onset of recessions in the past.
Of course, it would require a change in regime that overwhelms the central banks’ ability to unload a few thousand VIX contracts at “just the right time” and a vast number of HFTs and algos which are doing very nicely in the current BTFD environment.
Meanwhile, talking of mean reversions, there is another factor which makes the current timing slightly more attractive than it has been (ever actually).