BlueTrend Among Disappointing Quants

Futures traders have on the whole not fared well in

Margin Focus in OTC Default Risk

Chidem Kurdas

When Lehman Brothers collapsed in 2008, LCH.Clearnet took over huge derivatives  positions from the bankrupt bank. The clearing house successfully managed this and four other defaults, says Isabella Kurek-Smith, director and head of energy and freight markets at LCH.Clearnet. The experience demonstrated how important it is to require adequate initial margin—though some derivatives traders complain

QE2 End May Fuel Eurodollar Futures

Chidem Kurdas

The Federal Reserve having wrapped up its quantitative easing,  interest rates become subject to forces pulling in opposite directions. This creates opportunity for trading short-term rates. One type of instrument used for this purpose is Eurodollar futures.

While interviewing specialists on the topic, I was impressed with the growth of this market.  They pointed out some distinctive attributes of interest rate futures. 

Closed Centaurus Fund’s Upside

In the middle of the financial meltdown in December 2008, Centaurus Alpha Fund went down like so many other funds. Investors rejected the management’s lockup proposal and so the firm decided to close the fund. Selling the assets in the portfolio and returning the money to investors took years. Meanwhile, of course, markets recovered. 

Asia Search Leads to Macquarie

It sounds like US-based hedge fund investors are earning a lot of frequent flying miles with trips to Hong Kong and Singapore in search of promising Asian equity managers. Some of them have ended up with an Australian manager—an arm of investment bank Macquarie Group.

Bridgewater Benefits from Investor Caution

Chidem Kurdas

Wary investors may be pulling money out of the industry but favor certain big firms, among them institutional money manager Bridgewater Associates, which is one of the largest hedge fund shops.

Altman Questions Debt Market Conditions

Chidem Kurdas

The latest research on credit markets was presented this week at New York University’s business school. The conference was held at the appropriately named Paulson Auditorium—as in hedge fund manager John Paulson, graduate of ’78, who gave the school $20 million of the several billions he made betting against the housing bubble.

Bullish Barclays Suggests Volatility as Hedge

Chidem Kurdas

After successfully predicting “green shoots” a year ago, the analysts at Barclays Capital retain a positive outlook over the next quarter. Their likely scenario is moderate tightening by central banks in developed economies, where there is a lot of slack and no reason to tamp down growth, with little danger of a double-dip.

They recommend that investors maintain significant exposure to stocks and credit but balance this with a short position on US Treasuries and a long position in volatility both in equities and bonds. Volatility,  down to near-normal levels from the crisis spike, is an effective hedge because another spike could tamp down on markets.

Admittedly, Barclays has an interest in encouraging investors to buy volatility. It is the provider of exchange-traded notes linked to the VIX Index, which are an easy way to invest in vol. Hedge funds have taken to trading these instruments— see below. Larry Kantor, head of research at Barclays, says there are many ways to play volatility.

Hedge Funds Trade Volatility

Chidem Kurdas

Going long on volatility made a lot of money in 2008 and lost a bundle in 2009. Now, it sounds like many people are braced for another upsurge in vol.

Hedge funds are using exchange-traded notes linked to the VIX Index to make bets. The iPath S&P 500 VIX Short-Term and Mid-Term Futures exchange-traded notes (VXX and VXZ on NYSE Arca) are relatively novel instruments offering a low-cost way to go long or short volatility. ETNs are debt securities, but like ETFs they can be shorted.

Hedge funds account for 20% to 30% of the trading in VXX and VXZ, says Michael Schmanske, head of index volatility trading at Barclays Capital. Institutions account for another 30%. These are trading vehicles, not holding products, he said, speaking at a conference.

He sees uncertainty about what will happen when the Federal Reserve starts to withdraw volatility as driving people to buy VIX futures contracts and the VIX  ETNs. If volatility declines again, of course, owning the VIX will turn into a big-time losing trade as it did in 2009—VXX went down 75% in the past year.

But the ETNs  are better than owning S&P puts, Mr. Schmanske says.

iPath S&P 500 VIX Mid-Term ETN targets a weighted average futures maturity of 5 months while the short-term ETN targets maturity of one month. Volatility arbitrageurs use them to make spread bets, but others take directional positions. Some long/short equity funds have hedged their portfolio by buying the VIX.

Where does a volatility investment belong in a diversified portfolio? Some argue that volatility is an asset class that should have its own portfolio allocation.  Most investors, though, don’t treat volatility as an asset in itself but use it as a measure of risk.