Market uncertainty provides opportunities for volatility investors

Investing in volatility provides the prospect of sustainable and respectable performance versus a market outlook of continued uncertainty, according to F&C's Alternative Investments team.

During a press briefing in London, fund managers Stephen Crewe and Christopher Childs said volatility offers a true portfolio diversifier versus traditional asset classes showing increased levels of correlation.

Crewe and Childs have been working together since 1993 and have built a wealth of knowledge in managing derivative-based strategies via an established suite of hedge and UCITS funds, including the F&C Active Return Fund, an UCITS III Sicav.

Although many users of derivatives have a market direction mindset, F&C's Alternative Investments team believes that the most important pricing parameter to derivative specialists is volatility. To price an option, a trader must assume a level of volatility for the underlying instruments over the life of the specific contract. Knowing what the market expects, ie what is embedded in the price, allows a view to be taken relative to this expectation.

Whereas traditionally expressing a volatility view required the trading of plain vanilla options and hedging of the resulting delta risk, it is now common practice to use simple over-the-counter (OTC) contract for the difference between implied volatility and realised volatility.

During the briefing, the fund managers highlighted that even though an outright directional view on volatility remains a key driver of returns, it is important to recognise that implied volatility has both a term structure and a cross sectional skew structure. Just as it is possible in the world of fixed income to take relative positions on the curve, the same it is possible in the world of volatility.

Stephen Crewe, Fund Manager at F&C's Alternative Investment unit, said: "The key to successfully trading volatility is to be opportunistic, flexible and employ the full range of available instruments. We believe that investing in equity derivatives in general, and volatility trading in particular, offers access to an alternative investment strategy with the potential to add value and exhibiting low correlation to traditional asset classes."

The overriding aim of Crewe and Childs is to form portfolios that can generate repeatable, absolute returns that are non-directional. Christopher Childs, Fund Manager at F&C's Alternative Investment unit, said: "To be alternative has to mean you offer something truly different. The aim is to offer a truly alternative source of alpha rather than vehicles that purely look to offer protection."