Senior executives from market making and asset management outfits discussed how to improve investors' understanding of portfolio hedging.
"Portfolio hedging has been very sporadic this year. I don't think it has been a very in-demand strategy for the moment especially in the equity derivatives space," said Karinvir Gill (pictured), equity derivatives trader at Optiver.
"Investors were better off decreasing their equity holdings instead of buying volatility, because we never had a really convex payoff on those instruments - Karinvir Gill, Optiver
The flat demand is reflected in the persistent low level of the VIX index, Gill added, which is partly attributed to the underperformance of equity portfolio hedges from 2020 to 2023 in the face of a series of interest rate hikes.
"Investors were better off decreasing their equity holdings instead of buying volatility, because we never had a really convex payoff on those instruments," said the senior trader. "Portfolio hedging has not been a particularly common thought process for the moment."
In addition, there's been a real increase in systematic volatility selling that has been quite profitable based on the assets under management (AuM) over the last few years.
"The one place where we've seen increase in hedging is using very short-dated options, [such as] zero days to expiration options (0DTE)," said Gill. "And that's because investors like to hedge big economic events."
The trend shows that investors still view inflation or the Federal Open Market Committee (FOMC) meetings as the key risks to their portfolios.
In terms of technology, there was a notable time lag involved when banks were the key channel for participants to access markets. "Over time there has been a lot more direct access to markets and real-time access to hedging, if need be, which I think is an important evolution," said Gill.
"Accordingly, investors need to evolve how hedging strategies are executed, whether they use the ample liquidity on exchange or not," he said.
Awareness
"Not all investors are in favour of or understands the importance of hedging," said Bill Qie (below), chief executive officer (CEO) of Ingold Capital, a quantitative hedge fund with approximately US$8 billion AuM based in Singapore.
For a USD-denominated fund listed in Singapore with underlying assets exposed to the Chinese yuan (RMB), investors who eventually have a bigger say in their portfolios may choose not to hedge the foreign exchange (FX) risk, said Xie.
In view of the recent losses brought by autocallable products in South Korea and China, the asset manager pointed at a general lack of understanding about how these structures work, particularly the downside risk, among retail as well as accredited investors in these two markets.
"Some [investors] only look at the upside because it looks attractive," he said, adding that concentration risk is elevated as a result.
"Basically, for this kind of structured products, investors ought to be really careful," said Qie.
Compared with other risks, Ruobin Zhang (below), chief operating officer (COO) of Winfield Global Capital, a Chinese multi-family office, noted that market risk is "very hard or nearly impossible" to be managed and cited a Chinese expression - Yíngkuī tóng yuan /盈亏同源, meaning that profits and losses originate from the same source.
Zhang pointed to the nature of structured products, which are likely to trigger margin calls, and put leverage at greater risk when the maturity date approaches. According to Zhang, American option styles may bring more benefit to investors than European options due to their flexibility in exercise.
At Winfield Global Capital, an absolute return strategy is used to achieve wealth preservation, which is the main goal for the family office clients.
The COO noted that the biggest risk for the rest of the year will be the value of the US dollar. "The US [equity] index cannot go any further, [although] the interest rates or consumer price index (CPI) can be higher," he said.
Gill, on the other hand, sees geopolitics as the main risk with interest rate changes and the coming US election in November fitting under the risk umbrella. "Going forward, positivity is definitely there - [in] certain sectors. I think being very mindful of what's priced in is key," he said.
On top of global geopolitical risk, Qie at Ingold Capital added that policy risk remains the most significant risk in the Chinese market.
"We still don't see a clear direction where the policy will be for the rest of the year for China," he concluded.
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