View more on these topics

Klienwort tells a tale of two Devas

Private bank Kleinwort Benson and investment bank Dresdner Kleinwort have brought out two capital-protected Oeic funds, which aim for absolute returns by tracking volatility.

The Deva 90 fund has a target annual return of 4 per cent above the Bank of England base rate, while the Deva 80 fund aims for 9 per cent above the Bank of England base rate. Both funds also have a degree of capital protection – 90 per cent and 80 per cent of the highest net asset value respectively.

The funds were designed to make volatility accessible as an asset class. The rationale behind this is to benefit from the difference between implied volatility and real volatility on the S&P 500 index, thereby making use of arbitrage opportunities.

Implied volatility reflects how much an asset is likely to fluctuate in the future and this can be worked out by looking at the prices of options in the market. When options are priced, various factors are taken into account such as maturity and volatility. The Chicago Board Options Exchange Volatility Index – known as Vix, measures implied volatility for the S&P 500.
In contrast, realised volatility refers to how asset prices have actually fluctuated over time and is measured by looking at the S&P 500 index returns.

The Deva funds use derivatives to exploit the gap between the two types of volatility, while protecting the fund price by using a money market strategy based on a 0.2 per cent below the one-month Libor sterling rate. This strategy locks in 80 or 90 per cent of the highest net asset value each month.

According to Kleinwort Benson, the options market has historically priced in a higher level of volatility than is experienced in real time. One reason for this is that most investors buy rather than sell options, which means there is an imbalance of supply and demand that leads to higher implied volatility. Market shocks also drive up option prices and, at the same time, implied volatility.

This product could be too complicated for some investors and a higher level of real volatility than implied volatility would have a negative effect on the returns, as would lower interest rates.

Recommended

TCF could see firms ditch the commission model

Treating customers fairly will be used to force firms to abandon the “merry-go-round” commission model, says the FSA chairman. Speaking at a Treasury select committee meeting this week, Sir Callum McCarthy said the regulator cannot encourage a change in business model from the sidelines. McCarthy said TCF would be used to make it more difficult […]

Invesco sets up free training website

Invesco Perpetual is launching a free online intermediary training website to provide IFAs with access to up-to-date market views round the clock. The portal includes video and audio webcasts.

FSA says industry must lead distribution model changes

The FSA has set out its five key priorities for its review of the distribution of retail investments and has called on the industry to take the lead in reforming the market saying it is on the cusp of change. The FSA’s Retail Distribution Review was launched in June 2006 with the objective of identifying […]

Newsletter

News and expert analysis straight to your inbox

Sign up

Comments

    Leave a comment