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.

Buying volatility, for instance by buying VIX ETNs, has been a big-time loser in the past year. However, some traders consider the price very cheap now and expect some rebound.

The danger in the current situation is that almost all markets have gone up so much in the past 12 months that the  potential for further gains is limited. Mr. Kantor says unlike a year ago when assets were under-valued, there is nothing compelling in valuations now but they’re likely to get more expensive.

In China, where growth is fast and inflation an imminent risk, policymakers are expected to continue to tighten credit until the economy slows down.. That could have  spillover effect in the rest of the world and possibly push up volatility.

Rising volatility would be bad especially for high-yield corporate debt, says Ashish Shah, Barclays head of credit strategy. Using volatility as a hedge makes sense from that perspective.

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