Advertisement
UK markets closed
  • FTSE 100

    7,952.62
    +20.64 (+0.26%)
     
  • FTSE 250

    19,884.73
    +74.07 (+0.37%)
     
  • AIM

    743.26
    +1.15 (+0.15%)
     
  • GBP/EUR

    1.1717
    +0.0023 (+0.20%)
     
  • GBP/USD

    1.2623
    +0.0000 (+0.00%)
     
  • Bitcoin GBP

    55,470.37
    -432.10 (-0.77%)
     
  • CMC Crypto 200

    885.54
    0.00 (0.00%)
     
  • S&P 500

    5,254.35
    +5.86 (+0.11%)
     
  • DOW

    39,807.37
    +47.29 (+0.12%)
     
  • CRUDE OIL

    83.11
    -0.06 (-0.07%)
     
  • GOLD FUTURES

    2,254.80
    +16.40 (+0.73%)
     
  • NIKKEI 225

    40,369.44
    +201.37 (+0.50%)
     
  • HANG SENG

    16,541.42
    +148.58 (+0.91%)
     
  • DAX

    18,492.49
    +15.40 (+0.08%)
     
  • CAC 40

    8,205.81
    +1.00 (+0.01%)
     

Return of market shocks puts protection costs in spotlight

* Greece, Fed put hedging trades on market radar

* But cost pressures, low yields crimp demand

* Market signals show volatility up but low overall

* Some funds outsource complex hedging to banks

By Lionel Laurent

LONDON, June 18 (Reuters) - Financial market volatility is making a comeback, tempting fund managers into taking out protection against stock-market falls after a near-unbroken five-year bull run in the United States and Europe.

But growing interest in hedging trades is being tempered by concerns about costs, investors and bankers said, with fund managers wary of a drag on returns from buying derivatives or trades designed to cut risk.

ADVERTISEMENT

Active fund managers have both underperformed over the last five years and lost ground to cheaper rivals that track the market, raising the stakes over every slice of allocation - even the "drag" produced by keeping assets in cash.

Investors lacking resources to manage more complex hedging strategies are also balancing costs by outsourcing more of the trading process to banks and outside providers, they said.

Anecdotal evidence suggests record numbers of fund managers have taken out protection against a stock-market fall over the next three months, according to one Bank of America-Merrill Lynch survey, with asset prices swinging around Greece's ongoing debt drama and expectations of a U.S. interest rate rise.

Market signals are more muted, however. The so-called U.S. 'fear index', the VIX, has fallen by half since October. Its European equivalent has proven jumpier, surging to a six-month high this week, but it remains below 2014 peaks.

Several derivatives specialists said that while the absolute cost of hedging using options remained low, the cost-effectiveness of such trades as well as more complex structured products were holding some fund managers back. Years of low rates have wrongfooted investors' volatility bets in the past.

"With Greece fears kicking in and uncertainty surrounding the U.S. rate rise, the subject of hedging is coming back for investors," said Fabien Labouret, global head of equity and funds structured investment strategies at Barclays (LSE: BARC.L - news) .

"But yields are so low that buying protection can be a drain."

Hedging is also becoming more complex as volatility spills over into equities from other asset classes, such as currencies and bonds. Investors keen to hedge their portfolio or to profit from the uncertainty are offsetting some of the cost by outsourcing more of the trading process to banks.

"Asset managers who either don't have the time or the operational capabilities or the manpower to implement well-considered hedging strategies are reaching out," said Abhinandan Deb, head of European equity derivatives research at BofA-Merrill.

JPMorgan Chase (Swiss: JPM.SW - news) 's Nexus (Xetra: 522090 - news) platform lets wealth managers and pension funds build and track their own complex trading strategies - such as baskets of stock trades designed to help limit the impact of price moves in other markets - but keeps the execution of the trades and reporting processes with the bank.

"We fix all our costs up-front and outsource the majority of the operational risk of the strategy to the bank," said Nexus user Christopher Childs, fund manager at F&C Asset Management. "It saves us a tremendous amount of money as otherwise we would need more infrastructure...to handle the extra trading."

To be sure, hedging can still be a headache even if operational costs are minimised. Kola Capital Chief Investment Officer Arran Lamont said it was still difficult for fund managers to know how much of a particular hedging product to own and said some banks' hedging products lacked transparency.

But for the time being, it seems, the benefits of hedging via volatility indexes, options or structured products have in the current environment yet to trump the issue of costs - even when worries like a Greek default are buffeting markets daily.

"Investors who haven't taken evasive action (on Greece) are now paralysed because the costs to do so would be high, but perhaps not as high as missing the benefits if the expected resolution is reached," Deutsche Bank Managing Director Nick Lawson (Other OTC: LWSOF - news) wrote in a note to clients. (Reporting by Lionel Laurent; Editing by Mark Trevelyan)