While most Hedge(d) funds lost money last year, it was a great comeback for the long volatility hedge funds. The Eureka long volatility index, a broad measure of the performance of the hedge funds who take a long view on implied volatility, posted the biggest gains since the turmoil in 2008.
The performance since 2008 has lagged the SPX of course, but it is a good reminder for longer term investors to have some assets in long volatility strategies. Investors hate hedges as they “only cost” money, but there are many that would have loved to have some of their assets in the long vol fund space.
The Eureka long vol index (white) versus the VIX (orange).
The “problem” with playing long volatility as an investor is the fact that in periods of calm markets, the Pavlovian investor comes to the conclusion that long volatility strategies bleed theta. Most fund managers have zero incentive to engage into long vol “hedges” as they risk underperforming the benchmark as hedges cost money (get fired), while they get nothing more than a tap on the shoulder if they beat the index.
The second part of the dilemma, is the fact investors as an aggregate tend to “discover” hedges and long vol plays at a usually late stage. They end up buying too expensive hedges as they confuse pace with direction.
The chart below shows the SPX (orange) and net non-commercial VIX futures. In early October we warned of a way too complacent environment and a way too extreme net short VIX futures positioning. The crowd blew up, and has since then reversed the entire trade and we are now seeing investors rather loaded up on long volatility plays.
Note how we saw the same behaviour a year ago. If markets are to bounce further or not, we have no great take on, but the investor that has been chasing net long volatility plays has probably missed the train.
Source; charts by Bloomberg