Embracing fear by investing in fear itself

Risk off and spooked. That's current markets over the last two months or so. The ultimate white-knuckle ride seems scheduled to continue, at least, until the Greek elections in the middle of the next month. Scary stuff.

Scared about what? Despite the obvious: European Sovereign Debt, and slowdowns in the fast-growing China/India axis; aren't there still companies making money? Yes there is, but when the herd is spooked, prices are panicked in the wobbliest of fashions. Volatility.

Taking a leaf from Franklin D Roosevelt, the "only thing we have to fear is fear itself". Embrace your fear, buy the wobbly.

That seems to be the suggestion of Sean Daykin, Head of Investments at Emirates NBD Asset Managers, who in recommending the Amundi Absolute Volatility Fund, says: "We own this in our fund of funds. The main reason is that it tends to be a good hedge when markets are declining. i.e. As markets decline volatility [as measured by the VIX] tends to rise. This fund has dynamic exposure to volatility, so buys volatility when it is cheap and sells it when it gets expensive. When the VIX rises it makes money, particularly when the VIX is starting from a low level."

Fear then, a new asset class? Well you would not find that definition in many of your standard investment exams. So those being enticed should be prepared to define themselves as ‘experienced' investors. The "test" might be understanding the academic claim that the Amundi Fund style fits the asset class definition in three areas. Firstly, it is accessible through derivatives and options. Secondly, it is uncorrelated from both equity and bond/credit markets. Finally, the likes of Sean Daykin would argue that it might improve the overall risk/return ratio in a portfolio.

Risk rewards

Can we make money during the current wobble? According to Daykin: "In today's declining markets it means the fund makes money when all risk assets are losing money. This month it's up around 2.5 per cent. In 2008 it was up 28 per cent."

Those with their history books open will recall that 2008 was when Lehman's blew. The VIX Index hit a spike. Since then, the VIX Index hit spikes in March 2010 (first round of European Sovereign Debt fears); and the summer of 2011 (US Debt downgrade and revived European fears). These fearful spikes coincided with nice little earners for the Amundi Fund. More importantly, when the fund was not earning the big bucks it did not lose money. The downside: volatility over the last few years has been negligible.

A friendly spook this fund? Daykin would warn that there are risks: "The key risk is that equity markets perform well and volatility falls back to levels seen in 2005 to 2007 when levels were much lower."

Timing is everything

To Emirates NBD's credit, they first pointed out the Amundi Fund at the end of February within their Investment Advisory Service for HNWI's. At that time, risk assets were swimming along quite nicely, but the Emirates NBD Team had taken the view that they had become expensive. Good timing.

The fact that they are again recommending the fund during these most uncertain of times reflects something about their current, and negative view of the world, combined with a need to look for something to underpin the portfolio. "You could look at US treasuries as a hedge however with yields already at very low levels [1.7 per cent roughly] there isn't much scope for further rallies" Daykin says.

Limited alternative to fear? Buy the fear.

The writer is Chairman of Mondial Financial Partners.