JP Morgan, Source launch London-listed volatility strategy ETF

Feb 6th, 2012 | By | Category: Alternatives / Multi-Asset

JP Morgan and Source have further consolidated their partnership in the European ETF marketplace with the launch of the JP Morgan Macro Hedge US TR Source ETF (MHUU). The ETF aims to provide cost-effective, long-term exposure to volatility via a systematic strategy developed by JP Morgan.

JP Morgan launches London-listed volatility strategy ETF

The JP Morgan Macro Hedge US TR Source ETF tackles the contango problem with an innovative two-pronged strategy: it takes both long and short exposure to futures, switching from long to long/short depending the shape of the futures curve.

Volatility-linked exchange-traded products continue to attract attention and are designed to meet investors’ demands for portfolio protection during times of market disruption since volatility tends to spike when equity markets fall.

Lately, these products have also proved popular among investors looking for stand-alone volatility exposure as a way to profit from market stresses.

However, using volatility as a hedge can be very costly, for in normal market conditions a long volatility investment will typically lose value.

This is because most volatility-based products take a long position in VIX index futures, meaning investors can become exposed to the problem of contango, where each new monthly futures contract costs more than the expiring one. By systematically rolling into a more expensive futures contract, investors generate a negative yield.

The JP Morgan Macro Hedge Index, the fund’s reference index, tackles this problem with an innovative two-pronged strategy: it takes both long and short exposure to futures, switching from long to long/short depending on market conditions and the shape of the futures curve.

When the VIX futures curve is in backwardation (typically in times of market stress), the index takes a long exposure only. This allows it to capture spikes in volatility. When the VIX futures curve is in contango (typically in normal market conditions), a long futures position incurs a negative roll yield. The index therefore takes both a long position and an opportunistic short position in a nearer-term futures contract. By adding the short position the index aims to offset the negative roll yield and potentially generate a positive return.

The simulated performance of this strategy appears to be strong. According to data taken from the fund’s official factsheet, the index (excluding fees and transaction costs) has achieved returns of 99.0%, 63.4%, 36.8% and 12.5% in 2008, 2009, 2010 and 2011 respectively.  Annual volatility has ranged from as low as 9.2% to as high as 40.4%.

Rui Fernandes, Head of Equity and Funds Derivatives Structuring at JP Morgan, said, “Our Macro Hedge Indices combine long volatility exposure with a transparent source of absolute return. With more than a year of live track record and significant client investments in note and derivative format, the Macro Hedge family of indices has proven able to provide a robust tail hedge through equity market sell-offs, while mitigating the usual negative carry associated with traditional outright long volatility instruments.”

Commenting on the launch, Source CEO Ted Hood said, “Source continues to deliver cutting-edge content alongside our standard benchmark products. We believe that our ETF structure – with its operational convenience and its robust management of counterparty risk – offers a clear advantage over an OTC transaction, even for the most sophisticated investors.”

Hood also noted the interest in volatility as a tradable asset class. “We see escalating interest in volatility in today’s markets”, he said, “but the challenge is always the high cost, which makes this product particularly interesting.”

The fund, which is aimed at sophisticated and institutional investors, is listed on the London Stock Exchange (LSE) and trades in USD. It is registered for sale across much of Europe, including the UK. The fund’s management is 0.25% per annum. Investors should also note that the index calculation includes an embedded fee of 0.75% per annum.

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