Hedge funds are continuing to scale down exposure to equity volatility and that has dealers targeting traditional institutional equity fund managers. In the past, dealers have sold risk accumulated from structured retail investment notes to hedge funds. If new buyers for this risk can't be found, dealers may find risk limits curbed on lucrative structured note businesses.
Even though equity markets have ticked up in the last week, hedge funds have been taking risk off the table. A volatility salesman said the drop off in hedge fund risk appetite is noticeable but he added, "At the same time, we have some institutional funds which have not been burnt." These funds are more receptive to sales calls than hedge funds right now. Asset managers which have branched out in the last few years to offer long/short equity funds, or covered call writing funds are the main targets.
But it is not clear how successful this strategy will be. One portfolio manager at a large asset management firm in the U.K., noted funds like his often have more stringent investment restrictions than hedge funds, and it takes longer to approve new strategies. He said he has had calls from all the bulge-bracket firms, but added, "It's just not something we're interested in right now."
The slide in the popularity of volatility trading with hedge funds has been ongoing since equity markets plunged in May. "On and off, people are looking at it," said an equity derivative salesman covering hedge funds in London. Most hedge funds are looking to reduce risk rather than increase exposure, he noted. In particular, "Any suggestion of selling single-stock volatility is met with some skepticism right now," he added.
