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Market Volatility: How Will Hedge Funds Cope?

Posted On April 5, 2018 1:41 pm
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The recent elevation in market volatility should be a welcomed boon for hedge funds, especially those designed to profit from fast price swings or ‘tail risk’ events and promise to protect investors during down markets.

But as this article in the Wall Street Journal points out, these “crisis” or “black swan” funds that bet both on and against volatility are losing both ways.

The hedge funds have long pitched the idea they can protect investors and even prosper when markets fall sharply. But when market volatility returned, the big idea didn’t work.

The reason: The funds kept betting on sharp falls, but failed to profit from sharp rebounds–a disappointment after years of losing money in the bull market, according to portfolio managers.

The woes of these “tail-risk” funds, designed to benefit from market turmoil, show that in a month when many investors lost massive sums betting against volatility, wagers on it proved tricky too.

A CBOE Eurekahedge index of tail-risk funds fell 0.3% in February, even though the month was full of such sudden slumps: The S&P 500 lost 4.1% on Feb. 5 and 3.8% on Feb. 8, while the CBOE Volatility Index or VIX—the market’s so-called “fear gauge”—recorded its biggest percentage jump ever.

The VIX is now at around 20, after a year and a half of hovering barely above 10, as central banks exit years of unprecedented stimulus, trade spats escalate and lawmakers threaten to clamp down on technology giants. Last week, U.S. stocks recorded their first quarterly loss since 2015.

 

London-based 36 South Capital Advisors pitches funds designed to “substantially outperform in periods of extreme market movement and volatility,” according to its website. Its Kohinoor Core Fund gained 0.5% in February after losing 26.1% last year, according to numbers sent to investors and reviewed by The Wall Street Journal, leaving it down 2.6% in 2018. The firm’s Series Three Fund, down 8.6% last year, rose 0.2% in February. Returns for March aren’t yet available.

“February might be a tail event for some people, but it wasn’t in our minds. A minimum of 30% down is what I’d consider a tail event,” said 36 South CEO Jerry Haworth, adding that performance was in line with the firm’s expectations.

Paris-based Amundi’s $1.1 billion Absolute Volatility Euro Equities fund gained 1.7% last month, having lost 14.4% last year. Gilbert Keskin, head of volatility and convertibles at Amundi, said the VIX’s February surge “really was a tail event,” but that the fund was exposed to longer-term volatility through options and was unable to lock in most of its gains.

Tail-risk funds typically purchase options that pay out if market falls, but otherwise expire worthless. Versions of these strategies that bet on extreme and seemingly unlikely catastrophes are dubbed “black swan” funds.

 Related: Can a US-China Trade War Still Be Avoided? 

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Steve Smith

Steve Smith have been involved in all facets of the investment industry in a variety of roles ranging from speculator, educator, manager and advisor. This has taken him from the trading floors of Chicago to hedge funds on Wall Street to the world online. From 1987 to 1996, he served as a market maker at the Chicago Board of Options Exchange (CBOE) and Chicago Board of Trade (CBOT). From 1997 to 2007, he was a Senior Columnist and Managing Editor for TheStreet.com, handling their Option Alert and Short Report newsletters. The Option Alert was awarded the MIN “best business newsletter” in 2006. From 2009 to 2013, Smith was a Senior Columnist and Managing Editor for Minyanville’s OptionSmith newsletter, as well as a Risk Manager Consultant for New Vernon Capital LLC. Smith acted as an advisor to build models and option strategies to reduce portfolio exposure and enhance returns for the four main funds. Since 2015, he has worked for Adam Mesh Trading Group. There, he has managed Options360 and Earning 360, been co-leader of Option Academy, and contributed to The Option Specialist website.

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