Capstone Investment Advisors LLC’s Paul Britton, whose volatility hedge-fund firm oversees $2.5 billion, predicts that within five years his small sector of the industry will produce a pool whose size rivals some of the biggest managers today.
Britton sees the funds, which bet on the price fluctuations of stocks, bonds, currencies and commodities, taking over the types of options trades that banks did before regulators curtailed their ability to make bets with their own capital.
“I think there will be a $10 billion volatility fund in the next five years because the market will need it,” Britton said in an interview last week at the fifth annual Global Volatility Summit in New York, which drew record attendance.
The world’s nine largest investment banks had daily value-at-risk, a measure they use to gauge how much traders could lose in a single day, of almost $1.9 billion at the end of 2008 near the height of the financial crisis, said Britton, who founded New York-based Capstone in 2004. That dropped to an estimated $571 million in last year’s fourth quarter, and he said it could fall to $300 million once all the banks comply with new regulations over the next 24 months.
“This is the biggest market structure event of our generation,” said Britton, 40. “It’s a once in a lifetime opportunity.”
Volatility funds are attracting money from investors, even with market volatility subdued and many of the managers posting losses last year.
The strategy has pulled in $3.6 billion in the last three years, according to Chicago-based Hedge Fund Research Inc. The managers’ $14 billion in assets as of Dec. 31 still represents less than 1 percent of the $2.6 trillion invested in hedge funds.
“Investors are looking for ways to diversify their portfolios,” he said.
The funds, which got net deposits of $752 million in 2013, failed to make money last year because they perform best when markets are their choppiest.
As the U.S. benchmark Standard & Poor’s 500 Index climbed steadily in 2013, the funds lost 2.7 percent on average, as measured by the Newedge Volatility Trading Index. This year, they gained 0.4 percent through February.
Hedge funds industrywide rose 7.4 percent in 2013 and 0.6 percent in this year’s first two months, according to data compiled by Bloomberg.
Equity prices fluctuated in the first quarter of 2014 as investors fled emerging markets and Russian President Vladimir Putin’s annexed Ukraine’s Crimea region. Still, the VIX, which measures anticipated swings on the S&P 500, trades at less than 16, compared with the historic average 21 over the last two decades.
The volatility conference attracted 400 participants from pension funds, foundations, endowments and sovereign wealth funds this year, the most since Capstone and its peers started putting on the one-day event in 2010. The organizers turned away 150 people.
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