At FPM we understand
that checking in the rear-view mirror is not only an indicator of ‘things that
have come to pass’ but augurs ‘things that may come to pass’. So for the year-ahead,
when investor psyche is most trained on forward-looking signs, we aim to present
a strategy research. These market intelligence or views are confirmed by our Exchange Traded Product
(ETP) diligence. Our use of ETFs reinforces FPM's integrity as a multi-manager / FoFs
platform credentials.
A comprehensive
list of all ETPs ranked by YTD performance on 14th Nov’12 serves as the starting point for short- and medium-term view
recommendations. We believe this ranking-list and ETF prices as at
end-month Nov’12 serves as an apt data-point in spite of year-end window-dressing
noise. Following ETP data refers to these dates unless stated.
“Volatility in Vogue”
Volatility as an
investment sector, according to our ranking of all ETFs performance at US
equity market close on 14th November, was one of the punch-the-lights-out asset classes of 2012;
but ONLY if you were in a proxy that was short a volatility benchmark like the
VIX Index, as below:
| 11,384,800 | 146.85% | Volatility ETFs |
VelocityShares Daily Inverse Short-Term ETN ‘XIV’ posted a staggering 151.5% annual total return for year-ending Nov’12 (see below table of all ETFs over year). With approx. $370 mn in assets it is the 2nd biggest of volatility ETFs. Our universe for this sector study, incorporated all 17 volatility ETFs, as classified by ETFdb.
FPM’s macro perspective
envisages an inevitable pick-up in
volatility, at least a 68% probability event, based on the volatility exhibited
in VIX in the window period since Jan’09. Our expectation for increase in
equity volatility in 2013, especially after the relative lull in volatility
this year, stems from market-related macro concerns reverberate strongly.
FPM recommends a SWITCH trade with accompanying
trigger-event date. We favour the Barclays
ETN Inverse S+P 500 VIX Short-Term Futures ETN (XXV) for expectation of
benign volatility levels in 2Q13 and 3Q13:
From our market
understanding and statistical observations presented in below tables, and without
looking under-the-bonnet, the ‘XXV’ is one of the smallest-hitting ETFs in the
volatility class: with only about $4.5
mn in assets we’re mindful of liquidity concerns. Yet FPM commends it for:
a) Its forerunner launch in Aug’10, beating or
setting the trend for a hoard of other volatility ETF launches in Nov’10; these
others exhibit poorer ‘me-too’ arrivals. We noticed 6 ETFs incepted in November
that year from the VelocityShares stable alone!
b) Its
relatively longer track-record through business cycles is validated with strong
adjusted closing price performance 59.5%
total return since inception.
c) Other favourable FPM metrics in statistical
comparison with peers in the class, e.g. low market correlation, lowest monthly loss of only -2.3% across
all 17 ETFs and benchmarks, further encourages us to kick-the-tyres and
check-under-bonnet for allocation before by January 2013. See below for all ETF performance since their inception.
We perceive volatility increasing in 1Q13 to above 20 level as year-end dust settles and New Year optimism and
hope springs eternal i.e. risk-on activity. We expect volatility surges throughout
the year with the Fed’s FOMC stance about suspending its ZIRP or interest rate
capping policy, or indeed other policy-drivers. Recently these factors have
been prominent in capital market direction and volumes.
Barrons Focus on Funds reported on the
December 21st:
“…Wall
Street appeared to expect an interim deal today [on
“fiscal cliff Jackanory”], followed by
more meaningful resolutions in early January. Earlier, January and February
futures on the Chicago
Board Options Exchange’s Volatility Index were up 7%, and 6%, around 19,
respectively. The “VIX” nearly surpassed 20 for the first time [since June
25th closing] in a while this
morning and has pared it gain to 5% or so at this writing.”
For this 1Q13
increased volatility scenario FPM
RECOMMENDS the sector bellwether, un-leveraged long volatility short-term
VIX tracker, the VXX for sheer volume and liquidity for market-timing
directional trading.
Volatility ETFs from Micro Perspective
Volatility as an
ETF asset class ultimately tracks the CBOE
Volatility Index, otherwise known as the ‘VIX’ or ‘Fear gauge’. The
VIX, introduced in 1993, is calculated from prices paid for S&P 500 index options
expiring in the next 30 days. Though it has been around for nearly 20 years, by
the vary nature of its calculation it is not an investable asset. The ETPs in
the volatility category of the ETFdb database, actually invest in VIX futures
or, in the case of ETNs, are linked to indexes comprised of VIX futures.
The generally
passive index-tracking nature of ETFs is somewhat algorithmic and prudently warranty
case-by-case black-box examination. Traditional long-volatility funds bought derivative
contracts with implied future volatility, betting price swings will increase. When volatility is steady, the derivatives lose
intrinsic and time value moving to maturity, resulting in losses for the funds.
Hence the reasons why the two best performing ETFs in our study are short
volatility (inverse volatility), in this relatively calm markets.
Of long
volatility ETFs there is distinction in whether they reference short-term duration VIX futures (usually offering
exposure to 1st or 2nd month futures contracts), such as ‘VXX’, ‘VIIX’ and ‘VIXY’
etfs; or link to medium-term duration VIX
futures (exposure to 4th
month through to 7th month contracts), such as ‘VXZ’, ‘VIXM’ and
‘VIIZ’
Short-term
exposure generally exhibit higher correlation to changes in the spot VIX (high
beta). But because contango is often steepest at the short end of the maturity
curve, the adverse impact of an upward-sloping curve may be more severe. Indeed
short-term exposure ETFs fared worse over the year and since inception than
medium-term exposure VIX etfs. And as expected leveraged long ETFs
‘TVIX’,’TVIZ’
VXX, and other
long volatility short-term durations ETFs usually face higher rebalancing related
trading costs from periodic portfolio turnover especially in contangoed VIX
futures markets. This results in a premiums paid
to roll-over index option positions, i.e. the “roll yield” resulting from
contangoed markets. Contago in
futures is when the futures price is above the expected future spot price.
Consequently, the price will decline to the spot price before the delivery
date. This is the opposite of backwardation.
Micro drivers for volatility performance
While volatility
ETFs are not recommended as long-term buy-hold vehicles, they do provide opportune
trading and hedging possibilities.
The appeal of ‘pure’ long volatility exposure
via VIX futures is due to its strong negative correlation to equity
markets. Correlation ratio -0.83 of VIX to S+P 500 over the past year. So
volatility can be thought of as insurance for investor portfolios. Market
traded volatility products such ETPs tend to exhibit weaker negative
correlation, as our quant analysis shows. The study in fact shows that there
low correlation of long volatility etfs with S+P 500 index in the past year
of benign volatility. The median correlation for long exposure ETFs was 0.24.
Apart from understanding
the variables for implied volatility calculations, FPM monitors outstanding options on the VIX as auguring volatility price-action.
For instance outstanding positions on the VIX rose to 9.01 mn on 16th
October, the most ever according to Bloomberg data.
Our study also
found that CBOE Holdings Inc (owner of Vix) said in September that it intends to
expand trading hours for VIX futures to 24 hours from 8, five days a week,
starting in 2013. We can expect
increased liquidity in volatility trading, which may equally dampen or
exacerbate volatility spikes depending on the degree of herding in particular
views on asset class direction.
The ability to manage volatility similar to
that of US equity markets is developing with domestic futures and option
exchanges globally. For example, futures on volatility gauges for the Nikkei
225 Stock Average and Hang Seng Index started in February of this year.
Other benchmarks
such as HFRX Global Volatility Index may also get monetised expanding scope of diversified
volatility management.
The main factors other than being long or short of the stated volatility index:
Ø Two volatility ETFs are approaching thier meaningful 3-years track
record – the first of 17 in the universe incepted in Jan’09 (VXX)
Ø The oldest volatility ETF (VXX) is also the largest with $1.6 bn+ in
assets at Mid-November. The smallest one has ~$1.8 mn in assets (IVOP)
Ø Volatility as an asset category is classified under alternative
investments by prominent ETF vendor ETFdb (with Hedge Funds and Long-Short ETPs)
Ø ProShares VIX Short-Term Futures ETF (VIXY) is the only ETF approach
in the space, others are notably Exchanged Traded Notes ETNs.
Ø Only 5 of the 17 volatility ETFs (VXX, XIV, TVIX, UVXY and VIXY)
characterised daily average volumes over 1 mn shares traded; solid volumes indicates
tight bid ask spreads
Ø Another not small consideration in ETF allocation are the ever
present management fees, which is relatively the lowest of various fund
sectors, for basic index replicating performance.
We noticed that
being short or long volatility is an event-based trade. Often described as ride
to the sound of the trumpet, and then take profit when there! We identified ‘3 P+L periods /
option-settlement-rollovers’, Feb, Apr-May and Aug-Oct, were profit/loss
taking months for institutional ETF players, depending on which side of the
long/short volatility net position. Typically volatility may be expected to surge
in October, as investors try to exit losing positions before the end of the
year.
The short-term long
volatility ETFs experienced their worst
monthly price-basis drawdown in Feb’12 losing between -31.5% and -55.8%
(bear in mind that this ETF class is only approaching its 3rd year of
existence). The short-term derivatives investing inverse volatility ETFs (essentially
puts on S+P 500) experienced their worst monthly drawdown in Apr’12 ranging
between -2.3% and -25.5%. FPM SWITCH RECOMMENDATION the ‘XXV’ and the VOGUE STAR PERFORMER ETF ‘XIV’ experienced a modest monthly -2.3% and the worst drawdown of -25.5% respectively. The medium-term long volatility ETFs took worst
monthly loss in Aug’12 averaging -17.1% with outlier performance of -31.7% from
VelocityShares Daily 2x VIX Medium-Term ETN (TVIZ), due to its 2X leverage.
At
this stage we also present a Long/Short
VIX ETN. A discovery from FPM analysis of statistics, that finally
recognises a hedged volatility tracker.
“Another of the creative combinations of the
exchange-traded structure and volatility is the UBS E-TRACS Daily Long-Short VIX ETN (XVIX), a product designed to
exploit the steepness on the short end of the VIX futures curve. XVIX is linked
to an index that maintains a 100% long position in the S&P 500 VIX Mid-Term
Futures Index Excess Return with a short 50% in the S&P 500 VIX Short-Term
Futures Index Excess Return (an inverse-ETF position). The result is a product
that offers non-correlated exposure but hedges out exposure to the short-term
index, making it a potentially interesting for investors looking to achieve
exposure to volatility over a longer time period. During Wednesday’s session,
XVIX lost about 1%, a result to be expected then the gain on the short-term
futures index was more than twice as large as the change in the mid-term index…”
[Source: Michael Johnston of ETFdb on March 21, 2011]
FPM adduces that
most ETFs, at least in the S&P 500 option volatility space, experienced the biggest drawdown
synchronised with clearing months for futures and options settlements calendar.
Participants took money off the table / or switched trades in the volatility
space, based on ambiguous or benign economic and regulatory event-drivers.
Catalyst-drivers for the markets and wider economic sentiment are orchestrated
by authorities in ostentatiously retaliatory stance for financial crisis and
aftermath. Before the Lehman collapse the markets were crying foul of buyout-centric
momentum-driven trading disrupting company fundamental valuations. And now the macro
fundamentals are driven by global statutory agents. The point being that presiding investor sentiment on the prevailing
macro policy issues also caused profit / loss taking in volatility ETFs.
Completing our
micro event-driven 'regs-news' for volatility ETFs we edited together our ‘Prescient People News Annual’ of ‘proper’ macro and market policy
issues (as distinct from ‘news noise’), as below:
Volatility from a Macro Perspective
Re-emergence of
macro economic concerns, through escalation in state and national debt defaults
– by whatever label and however well stage-managed the propaganda and
behind-the-scenes debt restructuring progresses amid the de-leveraging cycle. We refer you to Ray Dalio’s “D-Process” as
an expert’s long-term macro view. Currently, the synthetic economic
confidence efforts (QE, TALP, TALF, Tax-holidays etc) and general lifeline
provided by global central banks is keeping the global economic ship on a
steady / even keel i.e. mitigated risks
scenario. Remember it’s not that long ago were there concerns about global
bank solvency. A once profligate wealthy sector is now transferring its
credit-boom-bust losses to future taxpayers! FPM knows that even a hedge
position can have a downside – if confidence and economic activity is not
restored in balance!
On this
Chicago-school of monetarist policy path, a scenario of Europe or other nation
or bloc-state running-out of money and/or stopping-the-printing-press via
geopolitical pressures like populous uprising, could make recent solvency
issues of financial institutions and the housing sector seem a mere trifle.
Statutory monetary expansion to quell systemic credit market risks of 2008 has exponentially
ballooned national and fiscal balance sheets / debts. For example, US Total Public
Debt Outstanding is US$ 16.3 trillion!
The souring of these government /
state debts, currently and seemingly only affecting irresponsible fiscal
management fringe countries and municipal states, blowing up i.e. credit default risks, is not an
incorrigible reality. viz.
Greece et al / ‘PIIGS’ and California See
below for more on “Volatility in a Macro Perspective”.
We can see from VIX
chart below that since the frenzied life-time high level of 80 in Oct 27 and
Nov 20 following Lehman bust in Sept’08, equity market swings have been less
volatile, none more so than in 2012, at pixel time. CBOE Volatility Index or VIX is now around a five-year low,
reflecting a steadied-ship which is the global economy proxy of S&P 500
constituent options’ implied volatilities!
For the record,
before the Lehman bust, the VIX level rose to a five-year high of 32.24 on Mar
17, 2008 the day after the Federal Reserve rescued Bear Stearns. The VIX fell for four straight years through
2006 and slid to a 14-year low of 9.89 in January 2007, a month before the
first reports of subprime losses. Previous highwater mark for VIX was 45.74 in
Oct 1998, when the collapse of Long-Term Capital Management LP destabilized
financial markets worldwide. Then of course cliff-fall in market sentiment sent
fear gauge to 80 levels in Autumn 2008. Can anyone see the lull-before-the
storm playing out again in similar yet shorter via volatility trading?
Source:
Yahoo.com and FPM
The “plaster-policy-fix recovery” in housing
and financials from maelstroms of the past is an opened Pandora’s box. This
author remembers how the developing nations defended a run on their sovereign
currency during the hot-money capital flight. For example, the Thai Bhat’s
devaluation was the catalyst for the Asian financial crisis in 1997-98. Only after hardy-denials of the
insurmountable problems did the national authorities capitulate and accept
realities of bubbles. Just as we now have ‘troika’ restructuring
nearly-out-of-control European fiscal and national debts, Thailand then also
had the IMF satraps pushing and shoving national prestige into accepting the capital
malfeasance facing it and the region. In a similar fashion, those liberal
marketeers not living in ostrich paradise definitely envisage other indebted
European nation following the way of Greece et al, leading to the final
capitulation of the European exchange rate mechanism.
The behavioural
finance aspect of the “collective institutional
market psyche” is an interesting aspect of understanding the reduced equity
volatility in 2012. In the context of the cycle in this double-dip financial
crisis, sometimes we get so inundated and eventually fatigued by, or simply get
used to scandalous corruptive news that we hardly register them, never mind
taking uproarious action. The Libor-fixing
revelation hardly caused a tremor, as reaction in the global equity markets
this year, though its rate setting effects trillions of referenced debt assets!
Incidentally this indicates the markets’ predilection and state of readiness
for a crisis. Hedges were at the ready and Libor-news-risk volatility safely mitigated
for now.
A certain period
of inveterate state in society and / or
institutions can stifle conscientious objective thinking, breeding hubris
and complacency maybe dare we suggest stagnation-economy.
Such as those of the disenchanted or disengaged economic workforce, who are and
were once productive units in cooperative societies. Those who are long-term unemployed
or in the conditioned-‘Black-Economies
of the World’ could reassert themselves gainfully. In some developing countries
women are now being considered to join workforce – Wow! To increase economic
activity or perhaps a liberalisation of the alter-ego of economics - no less! Of
the inveterate state of societies’ conscientiousness or interest in self-governing
facts, we are lazy or unspoken majority! When time framed status-quo societys’
behaviour and expression changes, suddenly and unexpectedly then panic arises
and the diligence becomes collective mass fear-flight to switch asset holdings.
They are dynamics of the fast world we domesticate.
Litigation
surrounding Libor and related-banks should cause mainstay financial institutions’
equity to stay in the mire of regulatory and litigious uncertainties for
longer. This to us means that the conventional
banking business model is in a state of slow flux. One might say ‘alternating’ flux! Allocation buckets
for financial investments is switching to Emerging Alternative Asset Managers. (email
me for FPM’s fund manager transactions ‘FMT’ efforts)
Equally as
interesting to consider that equity trading volume and general market direction
has been at range-bound levels, has contributed to lower volatility. At the end
of the first week of this month December, the YTD daily average volume is about 6.48 bn shares changing hands on
the New York Stock Exchange, the Nasdaq and NYSE MKT. At end-1H12 trading
volume was again light, with about 15.72 bn shares traded on aforementioned
bourses, well below 2011 daily average of 7.84 bn.
Other Volatility Plays:
There are so
many ways to play volatility, and volatility systems typically perform best
when “everyone else is confused” and
/ or when “excessive fear or greed among
investors exist” or “it would require
something to happen that is unknown today”!
Other than ETFs
there are other portfolio vehicles and investing strategies to understand and
profit from this volatility asset class. That is, up and down swings can be a
defining material investment, if principals / managers are “swinging” in their investment
outlook and approach.
Listed below are
4
Low-Volatility ETFs to Hedge Portfolios, as reported by Zacks.com:
PowerShares S&P 500 Low Volatility (SPLV) - SPLV tracks the S&P 500 Low Volatility Index, which consists
of 100 stocks from the S&P 500 Index with the lowest realized volatility
over the past 12 months. Est.May’11 with current AuM ~US$ 2.6 bn.
iShares MSCI USA Min Volatility (USMV) - USMV seeks to replicate the MSCI USA Minimum Volatility Index,
which is comprised of U.S. securities in the top 85% market cap that have lower
absolute volatility. Est.Oct’11 with current AuM ~US$ 465 mn.
iShares MSCI All Country World Minimum Volatility
Index Fund (ACWV) - It tracks MSCI All Country
World Minimum Volatility Index. Est.Oct’11 with AuM ~US$ 639 mn
iShares MSCI Emerging Market Minimum Volatility Index
(EEMV) EEMV is an ideal choice for the investors
looking to participate in the emerging markets growth while limiting their
portfolio volatility. Est.Oct’11 with AuM
~£603 mn.
Index Replicators
like ETFs produce average performance i.e. sector beta returns. However, alpha
stars in hedge funds with the right redemption / exit terms are the ones perform
best. If
The HSI Volatility Index (VHSI), a measure of Hang Seng Index (VNKY) option prices, is also
possible volatility play on wider markets; other than of course thr widely
accepted volatility benchmark of the S&P 500 companies.
As is the HFRX
global volatility index which gained 7% this year to Oct’12, outpacing the 4.8%
advance of its broader measure of hedge funds.
Of Volatility Hedge Funds: we initially examined sector
specialists from the smaller Asian universe. Our findings suggest there was a creative-destruction bias, at least in
long-biased volatility hedge funds. Artradis Fund Management in Singapore ran two volatility funds accounting
for most of its US$ 4.5 bn in assets in early 2009, propelling it to Asia’s third-largest hedge-fund group. It reportedly made
US$ 2.7 bn for investors as markets seesawed in 2007 and 2008. Artradis closed
in March 2011 after its funds lost US$ 700 mn in 2009 and 2010. Artradis
comprised former colleagues of Asia-office of Fortress Investment Group who had
started the Fortress Convex Asia.
Another example
of transactional creative-destruction in
hedge funds is the Sharp Peak Vega Feeder Fund, which invested in OTC
equity derivatives including volatility swaps, lost 12% in the first half of
this year and 18% since it started in Oct’11. The Hong Kong-based manager has
now shuttered shop. Another Hong Kong-based manager, DragonBack Capital, which
managed as much as US $600 mn at its height of fortunes in 2008, also closed in
Aug’10.
To get material
proportion in the advance of volatility trading trends we compare scale of Euro-Asia Volatility Markets. Asia-based
volatility funds tracked by Eurekahedge Pte managed US$ 212 mn of assets as of
June, less than one-tenth of the mid-2008 peak. In comparison, Newedge’s index
of hedge fund volatility sample of 10-fund constituents alone managed a
combined US$ 4.6 bn approximately.
On an encouraging note of “letting
your work be your fight…”, Stephen Diggle of the failed Artradis FM and of ex-Fortress
team, had started Vulpes Long Asian Volatility and Arbitrage Fund with mostly his own
money, a couple of months after in May 2011: “…He’s betting on price swings for government debt, currencies and
commodities.”
FPM seeks to engage Vulpes Investment Management with salutation of:
“…let your peace be a victory.” [Ki Action
Point]
Closer to home we are closely following the
fortunes of Maple Leaf Capital in London. Passing their tenth
anniversary of operations earlier in May. Congratulations Men! Maple Leaf was
founded by Michael Wexler and George Castrounis, specialising in volatility trading
and arbitrage across equity, commodity, currency, and fixed income markets.
FPM is engaging them and others on a sector
marketing diligence mission for in-depth coverage and peer study. Peers which
we will follow-up on include JD Capital
with similar operations establishment date in 2001, with a strategic prominent
FoFs backer FRM Capital. Also JD Capitals Tempo
Volatility Fund is part of the 10 constituents of the NewEdge Volatilty
Index.
Finishing on an anecdotal note we extracted these two statements
from our web-trawl research, one ironic and the other validation of volatility
assets:
``You're either going to be buying at the bar tonight or crying! There's enormous opportunity if you're an
options player because the volatility is there and if you hedge it right, you
don't care if it's up or down. But if you don't do it properly, you can lose a
lot of money… The [S&P 500] index may have its most volatile year since
2002. ''
Howard Silverblatt, an analyst at S&P
in New York,
commenting days before Lehman’s blowup.
``They make money when others don't. They act like insurance in one's
portfolio.'' Antonio
Munoz, CEO of EIM Management USA, a unit of EIM Group of Switzerland, commenting on volatility
funds it has held since 2002.
On behalf of FPM I wish my friends and colleagues and web-trawlers
the best of season’s festivities and holidays.… let our peace be an all deserving victory.
[@pixel time Ed deeply watching and then breaking-off from movie “The
Abyss”, Tomorrow evening looking forward to hanging out with my special fasionista
connections’ family in airy Cornwall.]
‘Seasons Sentiments & Cya in 2013! xk’