Friday, August 11, 2006

Door Opens for trading volatility

By Paul J Davies - FT

Retail investors will soon be able to bet on the racy world of equity volatility – usually the preserve of hedge funds and proprietary trading desks at investment banks – after the launch of a new fund.

Dresdner Kleinwort, the German investment bank, and Kleinwort Benson, the private bank, are launching two open-ended investment companies in the UK that aim to profit from the difference between implied and realised volatility on the S&P 500 index.

The funds, thought to be the first of their kind, have been made possible by innovations in the derivatives market and by the Ucits III legislation, introduced last year by the European Commission and allowing mutual funds to invest in instruments previously banned.

It joins a growing number of special investment vehicles to be listed in London focused on areas such as hedge funds and structured finance. It aims to list in mid-September.

Trading volatility has become increasingly popular in recent years, while specialists such as Volaris, a unit of Credit Suisse in New York, now offer volatility management strategies to institutional investors.

Developments in the world of derivatives have opened the door to trading volatility through instruments such as variance swaps. These swaps are bespoke derivatives constructed to give exposure to volatility that will be used by the new OIECs.

Serge Desmedt, managing director in capital markets at Dresdner Kleinwort, said the idea for the new funds, called the Deva 80 and Deva 90 Alpha Funds, came from the trend that the level of volatility implied by the price at which equity options traded in the market generally overestimated actual or realised volatility.

Mr Desmedt said the trend was observable back to 1990. “It’s one thing to spot an arbitrage opportunity but quite another to execute it.” Mr Desmedt said new financial instruments allowed funds to do this now.

He added that the S&P 500 index had been chosen as the basis for the funds because it was the broadest and most liquid index. “We thought it provided the best stability of returns,” he said.

Andy Halford, head of structured products at Kleinwort Benson, said the new funds would offer an exposure to an asset class that had previously been unavailable to many investors.

He said trading equity volatility would offer an investment that had historically given attractive returns with low volatility and low correlation to other assets.

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