Report warns on ‘worrying’ complacency in Vix index

A new report has warned of a “worrying” level of complacency among investors with models suggesting it should be sitting closer to 15 rather than 10.

The Vix currently sits at 11.2, but spiked several times during June before easing back.

Last week it rose more than 50 per cent due to a tech-induced selloff before easing back closer to 11. It also jumped to 15.6 following former FBI director James Comey’s testimony that Donald Trump had pressured him to drop investigations over Russian involvement in the US election.

These spikes can leave investors shorting the Vix index vulnerable, a report by ETF Securities states.

“Our model suggests the Vix should be closer to 15, not its current level of 10.6. Thus, our model indicates that market perception of risk should be much higher,” report author James Butterfill says.

“Perversely, we believe this disparity has been partly due to unstable macro events. A broad rise in the S&P500 is masking unusually low correlation between market sectors and individual stocks. This does not fully explain why the Vix has been deviating from our model, as this is a more recent phenomenon.”

According to the Commodity Futures Trading Commission, investors are holding record short positions – over 3x standard deviation from its historical range relative to long positions – suggesting shorting the Vix is an increasingly crowded trade, the ETF Securities report says.

It says shorting the Vix will become increasingly less attractive every time the US Fed hikes interest rates.

Investor views

Hermes Investment Management head of investment Eoin Murray says volatility has been low across equities, rates, FX and commodities and that the Vix has “never before under-priced political or policy uncertainty as much as it is today”.

“Central bank asset buying (the central bank put) has conditioned investors to “buy the dip” – market shocks are seen as alpha opportunities rather than marking the onset of uncertainty – supported by the low rate environment in which nothing seems particularly scary.”

Murray warns full equity valuations, declining margins and debt growth tend to precede a general upward trend in volatility “and those conditions are clearly present today”.  

Quantitative tightening could unnerve markets as liquidity is removed, even when it is well flagged in advance, Murray says.

Scott Berg, portfolio manager of T. Rowe Price Global Growth Equity fund, says hope and sentiment have lifted markets as consensus has shifted from despair to exuberance in the space of a year.

“While as fundamental investors we enjoy good news on the fundamental front, it is likely we will see the momentum in economic activity fade at some point, while our best estimate is that positivity around US policy is likely to miss a step at some stage. Either scenario will give renewed fuel to equity market bears that have been temporarily silenced, or quietened at least.”

While Neuberger Berman CIO for multi asset Erik Knutzen is surprised the Vix index is currently so subdued, he says investors should “make volatility their friend”, namely by diversifying portfolios using volatility-capture strategies.

“These can include income-oriented strategies, which are particularly helpful in a rising interest rate environment. And there are many other tools available that seek to capture return while mitigating risk.”