Volatility products are gaining popularity, yet fund selectors in Austria are struggling to decide which ones to use from the growing choice of absolute return and hedging strategies.
Another issue for selectors is liquidity. Even though the assets within the funds might be very liquid, the funds themselves might not be, says Klocker. This adds to concerns about using volatility products as a hedge for volatile times.
Other managers look at other hedge fund classes to find diversification. In Vienna, Kröll prefers the multi-strategy approach and allocation toward CTAs. "Diversification is key for us, this is also true for the asset class of alternatives."
Multi-strategy diversifies the risks among the range of alternative strategies, whereas CTAs have proved in the stock market dip of August 2011 that they can serve as diversifiers.
Many Austrian selectors have long looked at CTAs for diversification, as Gröschl admits. "CTAs offer some diversification and protect from tail risks, as downward trends offer opportunities for those products."
Klocker agrees in principle. CTAs might serve as an alternative for finding diversification, but they have a problem. If the crisis is not anticipated, CTAs also correct, and a market correction in a bull market is a tough environment for many strategies.
Last August, when the market was already falling before the sharp correction, trend-following strategies might work. But they struggle in volatile markets without clear directions, or in sharp downturns after rallies in stock prices.
This phenomenon hindered many funds from delivering good returns this year. According to data from Hedge Fund Research, CTA strategies have been the only style losing money this year (as of the end of May), whereas the average hedge fund strategy gained about 3%.
Adding to issues with performance, many selectors agree that clients have backed off hedge fund strategies after the crisis.
Feix says clients have become more risk-aware, partly as a consequence of scandals such as Madoff, that struck the Austrian market especially hard. C-Quadrat tries to deliver outperformance by trading actively, a strategy other industry players cannot follow due to regulatory restrictions.
Gröschl thinks Austrian institutional investors from pension funds, insurance firms and asset managers might not get around to tapping the absolute return arena and volatility strategies. "Current bond yields offer little value to clients. Pension funds and insurers will have to look elsewhere for returns."
With ten-year German bund yields offering little more than 1.2% at the time of writing, and even Austrian yields slightly above 2% for ten-year bonds, the ultimate hedge of the past three years - long safe bonds - is running out of steam. Selectors are thus on a quest for a hedge that delivers.
"Volatility products, even with the shortcomings they have, get ever more interesting, as the upside of bonds that have served as a hedge for so long becomes more limited," Klocker concludes.
PROBLEMS WITH OWNING VOLATILITY NEGATIVE ROLL YIELD: