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HH Investing In Volatility And The Advantages Of Separately Managed Accounts

There have been several articles highlighting the spectacular returns of inverse volatility product both this year and last. I shan’t go into the details but many of these products were up more than 80% last year and at the time of writing this article almost 70% this year.[1] Spectacular returns like this are hard to ignore, and reports of real trading returns are only fueling retail interest.[2]

But VIX linked Exchange Traded Products (ETPs) like VXX, XIV, SVXY and others were never designed as investments, and as I pointed out in an earlier article for Seeking Alpha ‘Making Volatility Investable’ their sponsors make this very clear in the prospectuses. VIX ETPs should instead be seen as trading tools, tools to allow active traders to express a short-term view on the volatility markets either to profit from speculation or to hedge a larger portfolio. As I recommended in that article, professionally Managed Accounts of these products offer investors one way to turn these trading tools into investable assets.

The relative stable markets of the last couple of years have unfortunately blurred this fact, but those of us who traded through the tech bubble of 1999/2000 and the financial crisis of 2007/8 remember well how seemingly stable investments quickly became unmanageable liabilities. By assuming highly leveraged banks or tech companies where stable long-term investments, many investors were caught without a plan when markets turned, many abandoning their positions and crystalizing large losses.

So what should volatility investors learn from this? Well for one that VIX ETPs are trading products and if investors are to use them for long-term investing they should commit to actively managing their exposure with a predetermined strategy or plan. Strategies offered online by ‘VIX Strategies’ and ‘Volatility Trading Strategies’ are good examples. A second point is to commit the time that is needed into managing those strategies. Some strategies offered by ‘VIX Strategies’ avoid taking overnight risk for example, and as such require daily trading at the open and the close.

For those who can’t commit sufficient time to actively trade the products, hedge funds may offer a sensible alternative. An investment in one of the many volatility focused funds delivers exposure to the returns of one of the many approaches used to make volatility returns more investable. Unfortunately, hedge fund investing is beyond the reach of many investors, and the opaque and commingled nature of their operations, is unattractive to many investors.

Separately Managed Accounts (SMAs) on the other hand are portfolios of securities directly owned by an investor and managed according to an agreed upon strategy by a professional investment manager. SMAs...