Simon Ho

Grant Samuel Funds Management and Triple3 Partners have warned investors not to take market returns for granted, as the CBOE volatility index – the VIX – hits near record lows.

The VIX index, often referred to as the Fear Index, is a measure of expected volatility on the S&P500 Index over the next 30 days. High VIX readings mean investors see significant risk that the market will move sharply, either up or down.

The VIX hit a low of 11.32 in May, and in the past a low VIX has frequently been a harbinger of significant market falls, says Mr Simon Ho, founder and chief investment officer of Triple3 Partners.

“This period could be the calm before the share market storm,” he says.

“The last time the VIX was at these low levels was at the start of 2007, the period immediately before the onset of the GFC.

“I expect that volatility levels will start to climb higher by the end of 2014, with a lot of uncertainties ahead for world economies.

“There is the housing bubble in China which will start to deflate at some point, the experimental quantitative easing taking place in Japan which will have unknown consequences, and the US’ decision to unwind its quantitative easing program which should see asset prices and risk premiums in that country return to more normal levels.

“Throw into the mix the conflagration in Eastern Europe, and the Euro-zone being on the verge of deflation, and you have a number of banana skins on the road ahead, waiting to trip-up the unwary.

“The backdrop against this is that equities are very fully priced. We have seen five years of a bull market where the S&P has gone from a low of 666 to sit at its current levels above 1900.

“Investors can’t afford to be complacent about their portfolio diversification,” Mr Ho says.

Along with a mix of equities, bonds, cash, alternatives and property, investors can also diversify by investing in volatility itself.

“Most investors see volatility as risk, but it is increasingly being recognised as a distinct asset class, and one which offers a largely untapped source of portfolio returns that are largely uncorrelated to equities.

An investment in volatility can be accessed through the VIX with the use of options and volatility derivatives. Mr Ho says it is a good natural diversifier.

VIX options have been one of the fastest growing option markets in recent years and now rank as one of the world’s most liquid – regularly trading over 1 million options contracts per day.

The Triple3 Volatility Advantage Fund, which is distributed in the Australian market by Grant Samuel Funds Management, aims to generate long-term absolute returns with its volatility-focused strategy to capture alpha from highly liquid exchange-traded VIX options, which are negatively correlated to equities.

Mr Damien McIntyre, director and head of distribution with Grant Samuel Funds Management, says: “The investment strategy is expected to perform best in periods where the S&P is falling. In periods where the S&P is choppy, the investment strategy is expected to generate positive returns, and where the S&P remains stable or increases only steadily, the investment strategy is expected to generate cash-like returns.”

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Simon Ho

Grant Samuel Funds Management and Triple3 Partners have formed a partnership that will see Grant Samuel distribute the newly launched Triple3 Volatility Advantage Fund to the Australian market.

Mr Damien McIntyre, director and head of distribution with Grant Samuel Funds Management, says Triple3 offers products and strategies that fill a genuine need in the Australian market – that of real and sustained portfolio diversification.

“Australian superannuation portfolios currently have the second highest allocation to equities in the world, at 54 per cent. They generally have high allocations to Australian equities for dividends and franking credits and to global equities, real estate investment trusts and listed infrastructure for income.

“Traditionally investors have sought to diversity their equity risk by investing in bonds, cash and more recently, other non traditional assets such as alternatives, with varying levels of success.

“Many alternatives strategies actually show strong positive correlation to equities, rendering them far less effective diversification tools for standard portfolio,” Mr McIntyre says.

Simon Ho, founder and chief investment officer of Triple3 Partners, says volatility has emerged as a distinct asset class in recent years that offers a largely untapped source of alpha for investors’ portfolios.

“With low correlation to other asset classes, volatility can be used to enhance returns and manage risk, and can be accessed through the VIX Index with the use of options and volatility derivatives.

“The volatility inherent in options markets is negatively correlated to traditional assets. It is possible to hedge out the risk of holding equities via options on the VIX Index. Although this has been recognised in international markets, it is relatively unused as a diversification option in Australia,” Mr Ho says.

The VIX Index, often referred to as the Fear Index, is a measure of expected volatility on the S&P500 Index over the next 30 days. High VIX readings mean investors see significant risk that the market will move sharply, either up or down.

“The level of volatility tends to be negatively correlated to equity indices, indicating that when equity markets fall, volatility tends to rise and vice versa. Options on the VIX Index allow investors to access this feature, which cannot be as reliably harnessed in other asset classes, making VIX an ideally suited instrument for targeting returns that are negatively correlated to the S&P500.”

VIX options have been one of the fastest growing option markets in recent years and now rank as one of the world’s most liquid – regularly trading over 1 million options contracts per day.

The Triple3 Volatility Advantage Fund, which will be distributed in the Australian market by Grant Samuel, aims to generate long-term absolute returns, which are negatively correlated to equities.

“The fund aims to deliver cash-like returns in periods when global equity markets rise or are flat, positive returns when markets are choppy and strong positive returns in periods when global equity markets fall,” Mr Ho says.

Mr McIntyre says the depth of experience and understanding of volatility in markets demonstrated by Triple3 means it was an easy decision to partner with the consultant and fund manager to distribute its funds in Australia.

“Triple3 has a seven year history and are recognised experts in the field of volatility. In addition to a role as an investment manager, Triple3 is a dedicated volatility research house and sells its research to professional investors as well as consulting to stock exchanges around the world,” Mr McIntyre concludes.

Planned Fund Features

• Easy access to the potential diversification benefits of volatility
• Daily liquidity
• Only deal in liquid exchange traded options and cash instruments
• Only deal in vanilla options; calls and puts
• Precise risk controls – limit loss to 5% in a VIX expiry month
• Proven track record of delivering targeted return streams
• No OTC derivatives
• No ISDA required
• No complex or hard to value instruments
• No lock-ups
• No gate
• The fund is not a serial options seller
• The fund is not a tail risk hedge

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