London
A FIVE-MONTH-OLD credit ETF became one of the largest short-volatility instruments in the world thanks to one big inflow last week, in a sign traders are finding fresh ways to bet on market gyrations.
The instrument from Tabula Investment Management, which gains when prices in global high-yield debt swing less than expected, took in a net 62 million euros (S$94 million) in the week ended Sept 20.
Known as TVOL, the short credit-volatility fund is now the largest tracking swings across markets in Europe - and among the world's biggest pure-play volatility products, according to Bloomberg data excluding inverse and leveraged instruments.
With 115 million euros in assets, TVOL offers a racy way to ride the credit bull on the heels of dovish central banks and continued economic growth. It's also a fresh frontier for volatility strategies.
With some traders fretting that the rewards of shorting equity price swings are vanishing, yield-hungry investors are digging deep to find alternative sources of returns.
"An ETF is a simple, straightforward way to access the credit-vol premium," said Markus Kress, a fund manager at Helaba Invest. With bond yields tumbling anew this year, Mr Kress says TVOL yields benefit over direct investments in cash bonds.
"When you think about investing in a high-yield bond index, currently you have a carry return of let's say 2 per cent with a drawdown risk of 25 per cent if the spread widens by 500 basis points," he said. "I think a credit-vol strategy offers a better risk-return relationship."
Mr Kress manages the 56.2 million euro HI-Alternative Risk Premia fund, which held around 3 million euros of TVOL shares at the end of July, according to regulatory filings.
Investors are shrugging off recession fears flashed in the government bond market on the back of resilient American growth, monetary stimulus and the relative health of corporate balance sheets. That's dragged down the yield for US speculative-grade bonds to 5.6 per cent, from 8.1 per cent in December last year, according to Bloomberg Barclays indexes.
TVOL's technical underpinning is the same that has spurred the decade-long boom in financial instruments shorting stock swings: the volatility-risk premium. That's the tendency for the market to price in a higher cushion for price swings compared with what comes to pass - giving traders an opportunity to sell options and earn a premium along the way.
The relative dearth of options sellers on the swap indexes relative to options buyers is one reason why the trade offers a risk-adjusted return.
The Tabula product tracks a JPMorgan Chase & Co index that simulates the gains of selling a so-called options strangle on a pair of credit-default-swap indexes referencing high-yield markets in Europe and America. Swings in the gauges have risen this year as investor sentiment has see-sawed between economic angst and risk-on cheer.
For Helaba's Mr Kress, this credit-volatility trade is "very attractive" compared with equivalent option strategies across stocks, interest rates and currencies - thanks to a lack of crowding.
But get it wrong and losses can be existential. A surge in equity swings caused the now-infamous XIV to shutter in February 2018, deflating assets in short-volatility strategies to US$413 million from US$3.7 billion before the blow-up, according to Bloomberg Intelligence.
Unlike its equity cousins, TVOL remains an emphatically institutional product, with shares trading at around 10,000 euros each. That means it's less likely to attract attention than instruments that track the Cboe Volatility Index, or VIX, the go-to benchmark for equity bets.
"When it's professionals getting burned, people don't care as much as when Grandma was holding XIV," according to Athanasios Psarofagis, a Bloomberg Intelligence analyst. "This is far off from that." BLOOMBERG
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