Bloomberg News

Asia Volatility at Six-Year Low Spurs Hedge Fund Wagers: Options

October 29, 2012

Asian hedge funds are forming to bet on the return of volatile asset prices, undeterred by the failure of predecessors after the 2008 financial crisis when governments stepped in to calm markets.

The HSI Volatility Index (VHSI), a measure of Hang Seng Index (VNKY) option prices, reached a six-year low earlier this month, and Japan’s Nikkei Stock Average Volatility Index is trading near a 20-month low. Fortress Convex Asia Fund in Singapore, with more than $50 million, and Voltex Asia Capital Ltd. in Hong Kong are tapping investor demand for returns independent of market direction and for protection against a rebound in price swings if government stimulus runs out of steam.

Actions by central banks helped push the MSCI All-Country World Index to its highest level since July 2011 and the Chicago Board Options Exchange Volatility Index, which tracks the cost of insuring against Standard & Poor’s 500 Index swings, to a five-year low. CBOE Holdings Inc. (CBOE:US) said in September that it plans to expand trading hours for VIX futures to 24 hours from eight, five days a week, starting in 2013.

“The last time we heard people say that in a low- volatility environment that volatility was never going to rebound was in late 2006, just before the recent financial crisis,” said Andrew Wong, a former Artradis Fund Management Pte manager who started Fortress Convex in May with co-worker David Dredge under the umbrella of New York-based Fortress Investment Group LLC. (FIG:US) “When people begin to be concerned that it might be permanent, it’s typically not too long before the regime shifts into something dramatically different.”

Volatility Climbs

Hong Kong’s HSI Volatility Index has risen 12 percent to 16.67 after reaching the lowest level since 2006 on Oct. 19. The gauge for price swings on the Nikkei increased 21 percent to 20.71 since an Oct. 5 low.

In the U.S., the VIX rose 4.4 percent to 17.81 last week, capping the first three-week advance since May. American options markets were closed on Monday after the securities industry canceled all equity trading as Sandy barreled toward New York City.

Outstanding options on the VIX rose to 9.01 million on Oct. 16, the most ever, data compiled by Bloomberg show. Futures on volatility gauges for the Nikkei 225 Stock Average and Hang Seng Index started in February.

The HFRX global volatility index gained 7 percent this year, outpacing the 4.8 percent advance of its broader measure of hedge funds. The record of Asia funds has been mixed. Asia- based volatility funds tracked by Eurekahedge Pte managed $212 million as of June, less than one-tenth of the mid-2008 peak.

Convex, Voltex

Fortress Convex Asia lost 3.1 percent through September, compared with the 7.6 percent advance in the MSCI Asia Pacific Index of shares. Jean-Noel Payer, a former Citadel LLC fund manager, started Voltex in August with backing from U.S. fund of funds Paloma Partners LLC, said a person with knowledge of the fund. Payer declined to comment on his fund’s assets or performance as the information is private.

A group of former traders of Dutch option market maker Saen Options set up True Partner Fund, a $34 million global volatility arbitrage fund that focuses on equity and equity indexes, in July 2011, said Chief Executive Officer Ralph van Put. True Partner Fund returned 7.2 percent this year through September, according to information sent to investors.

Sharp Peak Vega Feeder Fund, which invested in over-the- counter equity derivatives such as options and volatility swaps, lost 12 percent in the first half of this year and 18 percent since it started in October 2011. The Hong Kong-based manager decided to shut down its hedge fund after the losses, a person with knowledge of the matter said.

Historical Volatility

Historical 90-day volatility of the MSCI Asia Pacific Index (MXAP) has sunk to 14.5, down from its 10-year peak of 54.1 in January 2009. Declines in price swings led to the demise of earlier Asian volatility funds as well.

Artradis ran two volatility funds accounting for most of its $4.5 billion in assets by early 2009, propelling it to Asia’s third-largest hedge-fund group. It made $2.7 billion for investors as markets seesawed in 2007 and 2008.

“We hit the jackpot,” Stephen Diggle, a Singapore-based co-founder of Artradis, said in a phone interview. “The chances of a repeat of 2008 any time soon are very slim.”

Artradis Barracuda Fund returned 35 percent in 2007 and 27 percent in 2008 in its two best years. Artradis closed in March 2011 after its funds lost $700 million for investors in 2009 and 2010, Diggle said in May last year.

DragonBack Capital

Diggle started the $34 million Vulpes Long Asian Volatility and Arbitrage Fund with mostly his own money in May 2011. The multi-asset-class volatility fund, also known as LAVA, declined 16.5 percent this year through August.

The volatility fund ran by Hong Kong-based DragonBack Capital Ltd., which managed as much as $600 million at its peak in 2008, shuttered in August 2010. Its flagship Asia-Pacific Equity Multistrategy Fund lost 5.8 percent in 2009. That was the best year ever for Asian hedge funds, which returned 26 percent on average, according to Eurekahedge, located in Singapore.

Long-volatility funds such as Artradis and Sharp Peak traditionally bought derivative contracts with implied future volatility, betting price swings will increase. When volatility remains steady, the derivatives lose value as they move to maturity, resulting in losses for long-volatility funds.

Such funds thrived before 2008, when most other Asian hedge funds were long-biased equity managers whose performances moved in tandem with markets, said Julius Wang, Hong Kong-based managing director of Samena Asia Managers, which is backing True Partner.

Offset Losses

Investors from family offices to funds of funds and pensions used them to offset losses in other hedge-fund investments in the case of a significant decline in securities prices, said Diggle. The forced deleveraging of banks, and less borrowing by hedge funds and individuals, lowered the number of participants in derivatives markets, making opportunities for volatility funds harder to come by, he said.

The cost of contracts hedge funds use to wager on future price swings has increased, making profits harder to come by for long-biased volatility funds, said Graham Seaton, head of Asia- Pacific prime brokerage at Bank of America Merrill Lynch.

“Throughout 2012, tail risk protection has been expensive due to low supply from traditional sellers such as pensions and proprietary trading desks,” he said. “Volatility levels across all asset classes have hit multi-year lows, making conditions extremely difficult for traditional volatility strategies.”

Newer Funds

Some of the newer volatility funds are eking out profits by actively trading securities to offset some of the cost of holding derivatives that bet on rising price movements. True Partner, Voltex and Expedition Advisors have the flexibility to bet on or against volatility, based on whether they expect market swings to increase or decrease. That’s helped them fare better even when volatility is low.

True Partner’s relative-value fund uses computer models to spot which derivatives based on equity and equity indexes overprice or underprice volatility. It engages in about 1,000 trades per day, often exploiting pricing differences across regions, said Govert Heijboer, the fund’s chief investment officer.

“What we do quite a lot is cross-regional, like Asia vs. U.S. or Europe,” he added. “We trade more frequently and we trade more short-term.”

Asset Class

The 2008 financial crisis has heightened investor awareness that the correlation between different asset classes can rise in a major market shock, resulting in large losses in investments that appeared to be diversified, Convex’s Wong said.

Volatility funds tracked by Chicago-based Hedge Fund Research Inc. globally returned 2 percent in 2008, when the MSCI World (MXWO) Index plummeted 42 percent in its worst year on record. That year, the Eurekahedge Asian Hedge Fund Index fell 21 percent in its largest loss since records began in 2000.

“People who look at us really see volatility as a separate asset class,” said True Partner’s Heijboer. “We trade more from a long-short perspective and opportunistically.”

To contact the reporters on this story: Bei Hu in Hong Kong at bhu5@bloomberg.net; Tomoko Yamazaki in Singapore at tyamazaki@bloomberg.net

To contact the editor responsible for this story: Andreea Papuc at apapuc1@bloomberg.net


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