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Vulnerable to VIX: how selectors are dealing with record low volatility

Fund selectors on how they are navigating historically low levels of volatility.

Wall Street’s ‘fear gauge’, otherwise known as the VIX, has reached its lowest level for 20 years but how does this square with rising levels of investor uncertainty? We asked fund selectors how they are responding to the conundrum and many are viewing it with a wary eye.

Javier Lopez Casado, Finaccess

The VIX has been at near-historic lows for quite some time, but this is not a reliable forward-looking indicator when it comes to purchasing or selling an asset. Research shows that sustained rises in leverage are a much better signal of future market corrections. The extraordinary period of low volatility we are currently seeing in markets is largely a result of central banks’ unorthodox monetary policies, which have affected the risk- free rate and thereby all risk assets.

From a risk/return perspective, this has to be one of the most challenging investing environments, given the relationship between risk and return has become increasingly asymmetric.

In this situation, paying close attention to risk management and having the flexibility to concentrate allocations on assets whose risk asymmetry is still favorable is paramount.

Perhaps the greatest uncertainty investors face today is the imbalance created by central bank monetary policy since the financial crisis. These imbalances have exacerbated social unrest and spurred a wave of populist movements increasing geopolitical risks across the globe. As we approach the end of the current market cycle, the normalization of monetary policies, which implies a massive unwinding of central bank balance sheets, will be a delicate balancing act that we must monitor carefully, especially if inflation were to surprise on the upside.

Given our view of current risk asymmetries we favor a combination of absolute return and benchmark-aware strategies. Some of our preferred absolute return funds are Morgan Stanley Horizons Global Multi Assets Risk Control BBVA Absolute Global Trends , Santander Nabucco and Rothschild WM Wealth Strategy.

Our preferred benchmark-aware strategies include: Morgan Stanley Horizons Global Multi Assets Growth , BBVA Global Funds Strategic Allocation and Santander Turandot.

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Sebastian Contador, BCI Securities

A market with low volatility is unusual and can be unsafe because investors tend to allocate too much toward riskier assets.

We are concerned about possible market corrections, and are advising clients to either gradually top up liquidity or relocate funds to other markets that have lower valuations. We have also seen increasing fund flows to developed markets, especially to eurozone regions after the French elections.

At this time our market view is that the US is relatively overvalued versus European equities. Within fixed income, we prefer the short part of the yield curve rather than longer maturities.

In order to ride out a potential rise in market volatility, we recommend clients stay short in duration, such as US fixed income via the Franklin Templeton US Low Duration fund or the Alliance Bernstein American Income fund . For those more eager to take equity risk, we favor the Invesco Euro Equity fund, or in the small-cap universe, the Henderson Horizon Pan European Smaller Companies fund .

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Elina Theresine, K&B Family Office

Excessive stability breeds instability down the road. With the VIX at historic lows and an over- bought S&P 500 index, we recommend reducing exposure to equity risk.

When buying protection, we like the OROS Patrimonial fund as it has good cash management and a defensive approach. This balanced strategy offers dynamic asset allocation that can respond to a bear or bull market. Its priority is toward capital preservation and diversification.

For aggressive retail investors, an interesting alternative is to short the S&P 500 or bet on rising volatility. The VIX is now around 10, and it is very likely to bounce back. However, we advise investors avoid any vehicles directly related to it (e.g: VXX) because they have very expensive carry costs and an unattractive risk/reward ratio. We prefer to use the ProShares Short S&P 500 Trust ETF, the best method in our opinion to short the US market as a whole.

We also like emerging market ETFs for cost efficiency and for our Asia coverage, especially the iShares MSCI Emerging Market and the SPDR S&P Emerging Asia Pacific funds.

In the next few weeks, we will focus on the upcoming geopolitical concerns, such as the G7 meeting and president Trump’s ability to govern and boost US growth.

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Eduardo Pirajan, Grandes Patrimonios

The VIX’s low levels could point toward a tense calm in the market rather than describing real sentiment among economic agents. In an era where information flow is limitless and in real time it is worrying that uncertainty is not being reflected on analysts’ screens.

We’re not likely to be in a situation where all political and economic events in the short and medium term have been discounted. On the contrary, it is the lack of certainty that is diluting the largest movements in the market.

Under this scenario, it pays to have exposure to alternative vehicles with less correlation to the markets. Absolute return funds with a market neutral strategy are becoming an increasingly effective way to diversify and preserve capital. The DNCA Invest Miuri B fund , for example, invests in mid and large-cap European companies through a long/short strategy that seeks a volatility lower than 5%. In the last year it has shown very good risk management relative to its peers and maintains a return within the average.

On the other hand, the Pictet PTR-Corto Europe fund , is focused on capital preservation and seeks long-term growth along with performance alongside a low standard deviation.

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Diana Helliwell, Bolton Global Capital

With volatility at record lows, the probability of an uptick increases and it’s imperative to reduce portfolio risk through ample diversification.

Volatility has remained low due to positive economic indicators in the US, coupled with low interest rates and global growth. Capital markets are reaching all-time highs, and it’s easy to become uncomfortable investing in the current market environment. We see a potential risk in how the market digests ‘Trumponomics,’ and believe the positives have largely been priced into the market in the US.

We have been looking for value globally and are keeping clients in a measurable amount of strategies with hedging and other inversely- correlated funds, in addition to their core portfolios. Liquidity is one of our main concerns when exploring the alternative space and daily liquidity is essential to us. In addition, we look for funds that control volatility, provide protection on the downside, but also generate and produce risk-adjusted returns.

One of the funds in our alternative allocation gives access to various managers, with their top convictions being long/short equity in Europe, relative value in fixed income and event-driven corporate activity like merger arbitrage.

Strong investment managers are able to find market inefficiencies and generate alpha for their clients, and we select those funds that have a good track record, especially in times of crises, and with convictions aligned to ours.

* Opinions expressed are those of Diana Helliwell and not necessarily those of Bolton or its affiliated companies.

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