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True Partner article - Global cooling (in volatility): the calm before the storm?

Page 5: Volatility update January 2020

Traditional diversifiers are increasingly expensive, with less upside

After strong gains in 2019, most developed market government bonds now have a negative real yield again and there are over $11 trillion of bonds trading at a negative absolute yield, according to Bloomberg22. With US 10-year yields at 1.8%, German 10 year yields at -0.2% and Japanese 10 year yields at 0.0%23, one popular topic is whether bonds can continue to provide the same diversification they have in the past, as the floor in yields is a meaningful step closer than it was at the end of 2018. Despite the bond rally last year and the fall in yields more generally, it’s worth remembering that negative yielding debt ended with a negative total return24, which gives some pause for thought as to its long-term portfolio purpose. That is leading some investors to seek diversification in other areas, including in volatility funds.

Trading outlook

We don’t know which of these macro risks will grow into volatility events – but we find it hard to believe that all will pass unnoticed. For now we expect the rear-view mirror lesson of 2019 and much of the post crisis period – i.e. that buying the dip and selling volatility spikes is the way to trade – to still have a strong influence. That leads us to be more rigorous than ever in our analysis, and cognizant of both the costs of time decay and the knee-jerk volatility selling into events. However, we believe that it is also important to also be patient and not to forget the bigger market picture.

While aggressively selling volatility into spikes was endemic in markets over 2019 – and we must admit, successful – we believe that just as in meteorological trends, the fact that everything can seem calm for a time does not mean that risks have disappeared. While the frequency and severity of events in any given year is hard to predict in advance, we are confident that the global cooling of volatilities we have witnessed in 2019 is not a sustainable ‘new normal’.

As we saw in February 2018, sometimes even the largest and most deliberate hands holding the short volatility trade cannot withstand the infrequent but large jumps that are characteristic of the behavior of equity market volatility. Such events can create large trading opportunities for those who have been patient enough to wait. That does not mean sitting with a static position – but rather being thoughtful each day and focused on the highest conviction trades, and not being afraid to position in size when there are big opportunities.

With few optimistic on asset returns and limited room for additional monetary policy stimulus, if many traders do seek to sell volatility into market sell offs it could set up interesting opportunities as positioning could become more crowded as risks increase. If markets don’t quickly revert to an upward trend, downside potential may become more of a focus, with larger risks to unwind. That may mean some vol sellers will have to quickly cover their short volatility positions in a falling equity market.

Our outlook means that, for now, risk levels in terms of gross and net vega exposure are likely to remain relatively low while markets are quiet, but we keep focused on trading 24 hours a day, ready to increase risk rapidly if markets become more exciting. While the wait can be frustrating, we know from experience that it is important not to be blinded to the potential to jumps, as such changes can happen quickly, and the biggest opportunities may only be there for minutes or hours in a day. That was the case in February 2018 (more than once) and such focus has also been rewarded in some of our previous best months in the past.

True Partner is grateful for the strong support of our investors in 2019

From a business perspective, we have experienced strong growth in our assets under management in 2019 and are happy to have surpassed the milestone of $1bn in AUM as of December 2019. The IAM True Partner UCITS Fund launched in July, making our relative value strategy available to a wider range of investors. The UCITS Fund now has over $200mn in AUM and continues to enjoy strong growth. We are grateful for the continued support of our existing investors and have been humbled to welcome many other new investors from across the world.

We have continued to invest heavily in our technology and have also further strengthened our team, with the addition of Robert Kavanagh as a partner and Head of Investment Solutions in December. Robert joined us after spending 15 year at Goldman Sachs. Robert has extensive experience in evaluating volatility strategies and other hedge funds and working with a range of investors. He will be working with our investors, helping us to further expand our business and ensuring that our co-CIOs and PMs can remain at their screens as we grow. We look forward to introducing Robert to many more of you in the coming months and to his contributions to the business this year.

As we grow, we will remain focused on managing capacity in a prudent way. That may lead us to soft close the True Partner Fund this year. We would encourage investors who may wish to upsize their positions to make us aware of your potential growth plans in 2020, so we can manage capacity accordingly and avoid any disappointments.

Finally, we wish all our readers a happy and profitable 2020. We are working hard to deliver on your trust in 2020 and look forward to what we believe will be exciting market opportunities ahead.

The True Partner Team



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The full publication of this article is available as a PDF. Download it following the link below:
January 2020 Volatility Update - Global cooling>>

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1. nytimes.com
2. Sources: Bloomberg, True Partner, Eurekahedge. True Partner Fund returns are Class B, USD, net of 2/20 fees.
3. cnbc.com
4. Sources: Federal Reserve, True Partner federalreserve.gov, federalreserve.gov
5. Sources: Bloomberg, True Partner. Kospi 200 value is the simple average of the last two trading days of December and the first trading day of January as liquidity is more limited beyond 6-month maturities.
6 -12. Sources: Bloomberg, True Partner
13. wsj.com
14. For those intrigued, the consensus forecast for 2008 S&P 500 returns was for an +11.1% gain – this miss accounts for a significant part of the on average over-optimistic bias.
15. nytimes.com
16. wsj.com
17. libertystreeteconomics.newyorkfed.org; on liquidity see libertystreeteconomics.newyorkfed.org and bankunderground.co.uk
18. US PredictIt 2020 Senate Party Control Democratic, as of January 10, 2020
19. bbc.com
20. Data from policyuncertainty.com based on the paper: Caldara, Dario and Matteo Iacoviello, “Measuring Geopolitical Risk,” working paper, Board of Governors of the Federal Reserve Board, 2017”.
21. Source: policyuncertainty.com
22. Source: Bloomberg Negative Yielding Debt Index Market Value, as of January 10, 2020
23. Source: Bloomberg, as of January 10, 2020
24. Source: Bloomberg Negative Yielding Debt Total Return Index

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Published by Ralph van Put

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