Senior industry leaders of Asia-Pacific structured products providers expect significant opportunities in creating and promoting volatility index themes in Asia although recognise the challenges of doing so in light of issues around liquidity, regulation, and investor education.

Speaking on the roles of volatility at the S&P Dow Jones seminar “Making the most of volatility in both choppy and directional markets” in Hong Kong last week, the majority of panelists agreed that volatility is in fact an asset class and should be meaningfully incorporated into the average investor portfolio for diversification and risk management.

“Volume of exchange-traded volatility derivatives worldwide has registered spectacular growth in recent years, and with the extended trading hours for CBOE VIX contracts we anticipate even more activity in volatility trading during Asian hours.” said Paul Stephens, global head of institutional end-user business development at CBOE. “VIX has worked pretty well as a “fear gauge” building on its strong inverse correlation with equity market performance, which makes it a good instrument to hedge against tail risks.”

Buy side
Jason Mak, director of Avanta Investment Management, told SRP that there is certainly increasing demand for structured products referenced to market volatility from the buy side, and that there is not enough exchange-traded volatility products for local fund managers.

“There is no question that structured products offering exposure to volatility are in demand by asset managers and clients that we work with for both asset diversification and hedging purposes, despite the overhanging issue of liquidity, price transparency and a general lack of investor’s understanding,” he said. “I believe asset managers will be more comfortable using volatility-linked derivatives such as the VHSI futures at larger scale when they see the trading volume grows to a sufficient level near that of HSI China Enterprise futures. Until then we have to resort to either trading put options or shorting index future itself and other large-cap constituent stocks as ways to managing downside market risk.”

The institutional buy side has long recognised volatility as a tradable asset despite being somewhat reluctant to load up their position in volatility derivatives in their portfolio due to difficulty in convincing their own clients to whom they owe fiduciary management duties, said Tim Edwards, director of index investment strategy at S&P Dow Jones in the panel.

“The best analogy to the current situation is the commodity futures market back in the mid-90s to early 2000 where due to the lack of understanding market players have debated for ages whether these were viable investment vehicles,” he said.

Hurdles
However, bringing exchange-traded volatility products to Asian investors will not happen without obstacles. Chan Ahn, head of product development Asia Pacific at JPMorgan stressed the lack of liquidity and pointed that the insufficient number of market makers have made volatility a less desirable asset class than it should have been.

“While we have seen VIX products and the like gaining traction in US and Europe, the same thing cannot be said in Asia where there is a general lack of hedgers, liquidity providers, and system vendors to provide the much needed infrastructure for volatility trading,” he said. “We are very keen to see more retail following for volatility linked derivatives locally within APAC.”

PC Wong , senior vice president of derivatives trading, global market division at HKEx, pointed to other potential challenges including the general regulatory stance against product innovation and the absence of awareness and understanding of volatility products at the retail level.

Alpha v hedging
However, Reid Steadman, managing director of product management at S&P Dow Jones, said that more institutions seek to leverage volatility as way to generate alpha more often than hedging downside risk in the current low-yield environment and largely bullish equity markets.

“We work very closely with structured product teams of the sell side and more and more of these clients asked us to build customised indices surrounding the volatility theme over the last year to 18 months.” he said. “We have three European clients with global presence who have come to us with strong interest in developing products that provide combination of exposure to different asset classes and more often involve volatility based strategies.”

Steadman concluded that there is clearly a demand in the structured product channel for more customised volatility indices at least in Europe and we are seeing demand picking up in APAC as well.

“Certainly there is more to be done with respect to liquidity and technicality of introducing volatility products to a wider audience, the reality is that once more investors began to view volatility as viable category of investment, VIX and all other similar products will find their way to the Asian market,” he said.