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And the Winners Are: The Masters of Volatility

In times of market chaos, betting on volatility or mitigating it with derivatives makes the biggest difference. Non directional strategies are key. A number of Swiss managers are top performers.

Myret Zaki
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One characteristic of financial markets is that, no matter how unreadable the configuration is, some players will win, and even big.

During this pandemic turmoil, many funds made outstanding returns. They stood out in the midst of mass-losing strategies. Which asset managers delivered in the downturn? Being overweight in cyclical stocks was wrong. Being long small and midcaps didn’t help. Stock picking was far from conclusive.

The right strategies were found in the alternative universe. But hedge funds as a whole weren’t automatically the ideal place to be. Their overall March performance was down 8,74%, according to the Barclay Hedge Fund index. It still compares nicely with the S&P Total Return Index which was down 16,2%. But we want to be looking at green numbers to identify those who really ran up against the rapids.

Swings favor the least directional investing

In a recent column, we mentioned how short sellers were vindicated. But the trend was brief, because shorting is not enough. It remains too directional. Current market swings favor the least directional investing. Betting on a move, be it up or down, is the key.

Definitely, it is the masters of volatility who won the game in the first quarter. High vol strategies had been left out for a decade. Now with volatility back in grand style, derivative traders are busy. The macro traders, systematic and quant funds, Commodity Trading Advisors (CTA), and overlay strategists, who know how to use futures and options to buck the trend, are achieving alpha returns and uncorrelated performance. As the high volatility cycle could extend over the next months, volatility experts are likely to remain in favor.

Among the Swiss specialists, Dominicé & Co, an alternative boutique based in Geneva, treats volatility as an asset. Before March started, their volatility strategy was positioned «long vega». In other terms, they bet on a rise in volatility through buying options (calls and puts alike). «Vega» represents the change in an option’s price given a 1% move in implied volatility, be it upwards or downwards. Being long vega means betting that the option price will rise along with the volatility of the underlying asset. The increase in volatility equals an increase in profit, in a long option trade. As a result, their March performance reached 21,6%, and is up 19,7% year-to-date.

The «vega» players

Another «vega» player, the Chicago-based Trident Futures Fund, returned a net 10,3% in March. The fund, up 9,5% year to date, is a multi-model CTA which relies on buying and selling futures, including to short equities, using its own measures of market volatility and risk appetite (the Vega and Risk Regime models), to add stability to the portfolio, according to the Opalesque research site, which compiled the best performers in the first quarter.

But one of the highest performances is found at another Swiss firm, Zug-based QCAM Currency Asset Management, led by Thomas Suter (a former UBS investment banker), which reported a spectacular 55% return on its SI 30Vol fund in March, and 74% year-to-date. Their Systematic Intelligence Program is designed to achieve returns irrespective of the direction of the broader market.

Hedging strategies are in the spotlight

Overlay strategies are clearly in the spotlight, as these hedging strategies provide drawdown protection. Frankfurt-based Catana Capital's Overlay Strategy is up 22,6% year to date. The strategy is a customized overlay that uses DAX futures to stabilize returns.

«Passive diversification is not enough in certain market situations. Adding risk-off hedging strategies has brought considerable resilience to our portfolios», says Lionel Melka, porfolio manager at Homa Capital, a firm founded in Paris and active in Geneva, specializing in overlay strategies. «Buying volatility is a relevant strategy. It has a very low correlation to safe havens, adding a strong diversification from US Treasuries», explains, Jean-Jacques Ohana, Homa Capital’s CIO.

Volatility can be bought based on active market timing by following signals on the future VIX curve. «The best returns on this strategy are associated with the worst months for equities», says Ohana, showing very little correlation to the S&P.

Impressive performances among macro traders

Impressive performances were also found among macro traders, some of whom made huge money from the oil volatility play. Volatility is the driver of global macro strategies. These long, short, sometimes more than 300% leveraged bets using derivatives and based on global indicators need volatility to thrive. They need movements in stocks, currencies and interest rates.

The investing world took notice lately when a famous macro hedge fund, run by billionaire Chris Rokos, recorded a 14% gain in March, which brought its advance to 20% year-to-date. Funds seldom detail their strategy but a significant part of the return can be credited to option trades placed by Rokos already in the second half of 2019 on a recession in the US and on zero interest rates. A scenario that the (unpredictable) coronavirus pulled off.

Macro hedge fund firm Brevan Howard was also in the news with a 21% gain in the first quarter. Its FG Macro Master Fund, a pure macro strategy vehicle, bet successfully on a fall in central bank interest rates.

Uncorrelation with the stock market does exist

March 2020 will go down as a very special month in financial history, combining an economic shock, a market meltdown and very quick policy responses of unprecedented size. Only traders or algorithms able to navigate daily swings and neutralize market directions and correlations to the broader markets could stand out.

Looking at all these funds, it becomes apparent that non-correlation with the stock market does exist after all. It is fortunate that vol specialists are back to prove it.

Myret Zaki

Myret Zaki started in 1997 as a junior analyst in a Geneva private bank where she learnt the basics of equity research, before joining the daily newspaper «Le Temps» in 2001, where she was in charge of the finance section for 9 years. When the financial crisis broke in 2008, she wrote the investigative book «UBS, am Rande des Abgrunds» (originally published in French as «UBS, les dessous d'un scandale»), for which she received the Schweizer Journalist prize. She joined «Bilan» magazine in 2010 where she became Chief Editor from 2014 to 2019. Between 2010 and 2016, she wrote three other bestselling books, about Swiss banking secrecy, the end of the Dollar reserve status, and the rise of the shadow banking system. She has a Political Science Bachelor from the American University in Cairo and an MBA from the Business School of Lausanne. She is now a freelance columnist and a consultant in influencer and opinion leader strategies.
Myret Zaki started in 1997 as a junior analyst in a Geneva private bank where she learnt the basics of equity research, before joining the daily newspaper «Le Temps» in 2001, where she was in charge of the finance section for 9 years. When the financial crisis broke in 2008, she wrote the investigative book «UBS, am Rande des Abgrunds» (originally published in French as «UBS, les dessous d'un scandale»), for which she received the Schweizer Journalist prize. She joined «Bilan» magazine in 2010 where she became Chief Editor from 2014 to 2019. Between 2010 and 2016, she wrote three other bestselling books, about Swiss banking secrecy, the end of the Dollar reserve status, and the rise of the shadow banking system. She has a Political Science Bachelor from the American University in Cairo and an MBA from the Business School of Lausanne. She is now a freelance columnist and a consultant in influencer and opinion leader strategies.
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Myret Zaki