- Markets are at the start of a volatility cycle and will stay unsettled, Jerry Haworth, CEO of London-based hedge fund 36 South, said.
- 36 South, which gained more than 200% during the 2008 crash, is preparing for a market “avalanche.”
- Losses suffered by fund managers betting on low volatility earlier this week are just the “tip of the iceberg,” said Haworth.
LONDON – Feedback loops hidden within the structure of global markets are creating the conditions for an “avalanche” in equities, Jerry Haworth, CEO of London-based hedge fund 36 South, said in an interview.
“I think the market is structurally unstable,” Haworth, whose fund profits from market volatility, said.
“The analogy I use is the avalanche risk on the ski slope, which is enormously high because of the conditions. And in the village below they’re selling avalanche insurance cheap, way too cheap,” he said.
A sudden sell-off hit global stock markets earlier this week, amid concerns over rising inflation and interest rates. The VIX index, which measures volatility, saw the sharpest one-day spike in its history. The shock was exacerbated by so-called “target volatility funds,” that scrambled to sell stocks and buy VIX options.
“Dynamic volatility strategies I’ve always thought are absolutely ridiculous, because volatility is the unknown unknown. They won’t be able to catch a ‘gap’ and that’s exactly what happened,” he said.
36 South buys cheap, long-dated volatility options to set traps for market disasters. The strategy typically costs money when volatility is low, but nets huge profits when unexpected “Black Swan” events occur and markets collapse. One of 36 South’s funds gained more than 200% in the market downturn after the 2008 failure of Lehman Brothers, and it raked it in during the Chinese markets chaos of 2015.
“Everyone wants to write options at the bottom, and buy them at the top. It’s absolutely crazy but that’s what it is. It’s a volatility cycle, I’ve seen about five of them. This one has taken longer to get into place which means the damage could be greater,” said Haworth.
“We’ll have our most enquiries when the VIX is at 70. It’s our job to point out that fact when volatility is low,” said Haworth.
Large losses were localised in leveraged derivatives, such as the now-defunct XIV – which boomed when volatility was low but collapsed during the spike. But Haworth said that larger institutions are more vulnerable than they look to sudden changes in the direction of markets, because they have been trying to make easy money in benign market conditions.
“(The XIV) is only the tip of the iceberg for what institutions and pension funds have been doing in massive portfolios. These institutions have been overwriting calls and puts, basically to get more yield, which has been cannibalising volatility. Now they’re going to pay for it.”
“I think we’re heading for a meaningful correction and that this is the beginning of a volatility cycle that will stay at higher levels,” he said.
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