Volatility should be considered portfolio diversifier along with gold, says Barclays’ Nathan Bance

Volatility Exchange Traded Notes (ETNs) have been outperforming returns from gold since the summer, providing an even better hedge against market falls, argues Nathan Bance, director in UK Investor Solutions at Barclays Capital.

While the gold price has reached record highs in recent weeks as investors have sought to shelter their capital from market turmoil, Bance points out that the value of the iPath VSTOXX Short-Term Exchange Traded Note – an exchange traded product considered a measurement of European equity market volatility – rose around 100% between 1st July and 1st November. This is compared to gold which rose around 15% over the same period. Barclays’ ETNs are senior, unsecured, unsubordinated debt securities issued by Barclays Bank PLC, linked to the performance of a market index.

“The gold price has rallied sharply as investors have flocked into what is perceived as a safe haven. But while gold has performed strongly, volatility has performed even better. The interesting thing is that this is not a one-off, unusual event: volatility has been, and remains, a consistently reliable hedge against market falls and tail risk events – potentially more dependable than gold,” he said.

Bance highlights two periods in which gold did not perform as investors might have expected. Following the bursting of the tech bubble in 2000, both the value of gold and equities fell in that calendar year; while between 14 July 2008 and 1 November 2008 – a period encompassing the collapse of Lehman Brothers, which initially caused gold prices to spike upwards – gold fell 24.5%, with the S&P 500 index falling 20.6%.

“The point is that gold, for all its undoubted benefits, is not an infallible event hedge. Investments linked to volatility, however, can be considered to have a higher probability of diversifying portfolios because volatility is very often negatively correlated with equity markets. Volatility also tends to inversely outperform falls in markets because it typically changes more sharply than the underlying indices, particularly during major market falls.”

“We simply believe that, even for the most bullish gold investor, it makes sense to use more than one portfolio diversifier, and a worthy alternative should be volatility. Gold ETFs hold in excess of $114bn – as at the end of Q3 2011 – whereas the current investable amount in pure long volatility positions is no doubt a fraction of this. As a result, we would anticipate greater investor use of volatility in years to come.”

 

Nathan Bance is director UK Investor Solutions at Barclays Capital.

 

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