The tranquility of Wall Street's 'Fear Gauge' continues to baffle investors, given the market uncertainty. But betting on rising volatility has been a widow-maker trade, says US markets editor Robin Wigglesworth.
Volatility is once again dancing the limbo and seeing just how low it can go. The VIX index of expected US stock market turbulence has averaged about 11 points this year, compared to nearly 16 last year, and their long-term average of almost 20 points. The equivalent volatility gauges for treasuries and currencies are also pretty becalmed.
This could be called the volatility paradox. The tranquillity of "fair indices" compared to the heightened post-crisis uncertainty is one of the finest industries perennial [INAUDIBLE] talking points. Implied volatility has mostly been low due to actual realised volatility also being remarkably subdued, a phenomenon often attributed to the soothing monetary morphine offered by central banks. But that argument looks a bit weaker right now, whilst VIX has really been lower, the Federal Reserve will almost certainly raise rates next week.
And the ECB is sounding a bit more hawkish, as well these days. Then there are the upcoming Dutch and French elections and ongoing concerns about equity valuations, with the US bull market celebrating its eighth birthday on Thursday. Now this clearly something structural going on with volatility, which has evolved from a concept to actual asset that banks and investors can slice, and dice, and trade.
There are now several big exchange traded funds that retail investors use to bet on the VIX index rising. And on the other side of the ETF, a most sophisticated hedge funds that systematically bet a volatilities mean reversion, which actually helps subdue VIX. Now this can be a bit like picking up pennies in front of a steamroller.
When turbulence does erupt, the losses are painful and immediate. But over time those short [INAUDIBLE] have been extremely profitable, with the VIX persistently trending downwards. Indeed, betting on falling volatility through the "XIV" ETF would have netted investors almost 32% annually, since the start of 2011.
And on the other hand, long volatility ETFs have been simply phenomenal wealth destroyers. Over $16 billion that has flowed into them since 2010, a staggering 14 billion has in practise evaporated like that. Now this dynamic could change, but investors should clearly think twice before betting on renewed turbulence.