Dearth of direction

Chris Jeffery

The world can appear as a pretty confusing place at the moment. One day's gloomy financial predictions become upbeat forecasts the next. Then it's gloom again, followed by a brighter outlook, which turns out to be yet another false dawn.

Even pragmatic and forward-looking market participants say their views of exactly when a protracted economic recovery will take place in Europe, Japan and the US swing radically from week to week, dependent on the latest statistics and central bank and government initiatives to shore up major economies.

Former US Federal Reserve chairman Alan Greenspan told a conference in July, that the speed of intervention is the most critical element in determining whether the economic downturn in the US will prove a short-term phenomenon. It's hard to tell whether the Fed and US Treasury actions - most recently placing secondary home loan buyers Fannie Mae and Freddie Mac into US government 'conservatorship' - have been swift enough to prevent a long-term malaise in the US economy, along with a knock-on impact for export-led economies in Asia.

Apparently the AAA-rated tranches of residential mortgage-backed securities (RMBSs) in Australia (see news, page 8) are pretty secure, says that country's central bank. Meanwhile, there has been some limited pick-up of RMBS issuance in Australia and South Korea (see pages 28-31).

Overall, however, investors are struggling over where to park their cash, as they grapple with the likely direction of markets and with the timing both for entering and exiting investment positions. This environment signals that realised volatility is higher than it has been for many years. This should provide opportunities for dealers and hedge funds that have promoted the benefits of alpha-based strategies.

Some dealers, such as Deutsche Bank, say volatility-based strategies are in strong demand, as the push and pull of bull and bear investors is likely to keep volatility above historic averages for at least the rest of this year. Indeed, 40% of respondents to the German bank's annual Alternative Investment Survey of more than 1,000 hedge fund investors around the world, managing nearly $1 trillion in assets, say equity volatility will prove a top-performing strategy for the year.

But choosing a product at the retail investor level is a little harder. Most major dealers offer hedge fund replication indexes that mirror some of the strategies deployed by leading hedge funds. Yet knowing which one will outperform another is almost as difficult as selecting one volatility-based hedge fund over another.

While volatility strategies do appear to be the right way to go in choppy markets, convincing investors they should shift their safely hoarded cash is another matter.

- Christopher Jeffery.

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