Absolute Volatility Arbitrage Plus: Amundi Asset Management

While volatility is sometimes considered a risk indicator, it is more a measure of an asset’s variability: a measurement of the dispersion of an asset’s returns relative to its average. Since 2008 its popularity as an asset class has been rising. Volatility represents an interesting investment solution for investors looking for diversification as well as low to zero correlation with traditional asset classes.

The Absolute Volatility Arbitrage Plus fund is designed to do all that while generating returns by exploiting volatility market inefficiencies. The target is to produce under normal market conditions Eonia [Euro Overnight Index Average] plus 4% and on average around 8% a year.

The fund, a high-octane version of the Absolute Volatility Arbitrage fund, seeks out volatility arbitrage opportunities from a wide range of strategies: convertible bonds, equity indexes, single stocks and interest rates.

Volatility arbitrages on convertible bonds benefit from valuation spreads between the implied volatility of the option component of a convertible bond and the historical volatility of the underlying equity or the implied volatility recorded on options on the underlying equity.

For equity indexes the volatility arbitrages take advantage of expected convergence/divergence on volatility between different indexes or for an index between different maturities. The volatility arbitrages on single stocks tap the inefficiencies on volatility between two single stocks in the same sector or in a basket of single stocks against an index. Interest rate volatility arbitrages exploit the expected convergence/divergence on volatility between two different geographical areas, within a single area or between two different maturities.

Amundi, a pioneer in Europe on volatility products for over 12 years, has had some success in running the strategy. Overall Amundi manages €5.9 billion ($7.8 billion) in volatility strategies, including €1.2 billion ($1.6 billion) in volatility arbitrage alone.

The co-heads of volatility and convertible bonds, Eric Hermitte and Gilbert Keskin, manage the Arbitrage Plus Fund. Hermitte has been a volatility arbitrage portfolio manager at Amundi since 1998 and previously was an options trader for Dresdner Bank for four years. Keskin joined Amundi’s research department in 2000 and became a volatility and convertible bond manager in 2002.

Together they oversee what has become a proven investment process with a 12-year track record of managing volatility arbitrage. For Hermitte the investment philosophy of the fund is simple: to benefit from any discrepancies between the volatility of two instruments that are normally correlated. “The idea is to have an absolute return approach based on carry strategy and relative value strategy,” he says.

“The idea is to benefit first from mean reversion in volatility so in the long term you can observe volatility as a cyclical. This means you can take into account this mean reversion by implementing some strategies benefiting from discrepancies at a particular time. You also have some relative value strategies that work with two well-correlated instruments or two markets, say in the same sector, for example telecommunications: two companies that at some moment see a widening in the volatility spread. You can arbitrage this discrepancy,” explains Hermitte.

The investment approach is simply to benefit from inefficiencies in volatility. Because not all players are volatility specialists, Hermitte can find opportunities others may not spot. The investment objective centres on absolute return with low correlation to main asset classes, using a flexible approach with both long and short relative value volatility and carry strategies aimed at opportunities from equity indexes, single stocks, convertible bonds and interest rates.

The idea of a higher risk/reward version of the strategy was to give investors a more dynamic fund delivering a better return with a bit more risk. But even this extra risk is limited. There are strict value-at-risk constraints put on the fund. In addition, Hermitte will only trade highly liquid instruments.

Risk control, he says, is a priority. “Value at risk is essential at Amundi. It is necessary to keep the fund below its maximum VaR limits. This means sometimes we need to cut positions in order to limit the risk of the portfolio,” he says, adding, “But if I have to make a choice, I think risk control is the priority. If we’re not sure about the risk of a strategy, if it’s difficult to measure the risk of a strategy clearly, we’d prefer to avoid implementing the strategy idea.”

In order to limit the risk, each exposure is also measured in relation to the strategy used. Since it is a pure volatility fund with no exposure on the different underlying assets, Hermitte says it is relatively easy to limit downside risk and hedge those underlying assets.

Another factor that may make the fund attractive for investors is the focus on liquidity. Like many Ucits funds, it offers daily net asset valuation and much more frequent redemption terms than many hedge funds. This is only possible because of the emphasis on trading highly liquid markets and instruments.

“We base our strategy on liquid instruments,” he says. “The idea is to first use quantitative tools in order to make a first selection between opportunities and after that we have a discretionary approach to look if this quantitative signals is a real opportunity.” The result is a mixed quantitative approach with discretion.  

“That’s the reason why most of our ideas are a mix of quantitative signals and discretion. Sometimes when we have an idea coming from a company announcement, we look to see if this is a real opportunity based on quantitative data. If not, we don’t implement it.”

For the strategy to work, Hermitte says they just need volatility. The perfect environment is one with enough volatility to find opportunities. “When volatility is very low, it’s more difficult to find opportunities and to deliver return from carry strategies,” he notes.

Not every idea goes to plan. Like many others, the fund was caught out by the performance of the Nikkei. “We benefited from Nikkei volatility discrepancies last year very strongly. With the change in economic policy we had a strong jump in the Nikkei volatility.”

The trade was originally to sell the S&P and go long Nikkei volatility. “We are currently long S&P and US stocks and short the Nikkei but if there is a strong widening of this spread, it could be an issue for us because it’s one of our strong conviction trades this year. The main risk is to be back in a low volatility regime as you were in 2004 or 2005 which means that we have more difficulties to find opportunities.”

Other factors also influence how he approaches those opportunities. “It is essential, especially for the index strategy, to have a macro view, especially in the current context with a lot of liquidity injected by central banks. So for the index and interest rate strategy, it’s very important to have a macro view, macro convictions,” he says.

For convertible bonds or single-name stocks he says it is more important to have a bottom-up approach. “In fact if you look at the differences between the fund and its strategies, it’s a combination of bottom-up and top-down.”

Hermitte also focuses on improving the performance of the fund. But adding new instruments is not always that easy. He thinks the move to exchange clearing of OTC derivatives could allow the fund to take advantage of a new source of liquid instruments with limited counterparty risk. Both, he says, are important in determining whether the fund will move into that area.

“We are always looking at new opportunities and not only in Europe. Although we are based in Europe, it’s easier for us to implement strategies on European instruments in European markets but we try to widen our horizons. However, we are not involved in emerging markets because of the lack of liquidity. It just isn’t high enough for us at the moment.” This includes China, something Hermitte is keeping an eye on.  He hopes that in two or three years he will be able to implement new strategies on Chinese options.

Meanwhile, Hermitte is keeping the focus on delivering positive returns for investors, no matter what the current economic environment. “It’s true we need volatility to perform. It there is no volatility in the market, you have less discrepancies, less opportunities for us to implement our arbitrage strategies. But what we mean by following an absolute return strategy is that it’s possible to perform in different market environments. If you look at our track record, we have been able to deliver returns whatever the market context.”

Fund facts
Fund name: Absolute Volatility Arbitrage Plus
Portfolio managers: Eric Hermitte and Gilbert Keskin
Contact: www.amundi-funds.com; www.amundi.com
Investment manager: Amundi
Launch date: December 19, 2011
Assets under management: €295 million (April 10, 2013)
Annualised net return: 1.64% (April 30, 2013)
Sharpe ratio: 0.82 (April 30, 2013)
Strategy: volatility
Share classes: AE (all investors); IE (institutional investors); SE (distributors)
Custodians: Caceis Bank Luxembourg
Domicile: Luxembourg (Ucits IV compliant)
Management fee: 0.30% (AE);  0.10% (IE);  0.3 0% (SE)
Performance fee: 15% of the cumulative performance above Eonia
Minimum investment: $500,000 (institutional)
Redemption/liquidity terms: net asset value (NAV) calculation daily; Luxembourg dealing days before 2pm (Luxembourg time)