It’s been a long and painful year for hedge fund manager Deepak Gulati, who finds himself on the wrong side of one of the most profitable trades in town.
His Argentiere Fund lost money for 14 straight months through April by betting on rising market volatility, erasing all the gains since it started in 2013. The assets it oversees have almost halved. By comparison, an exchange-traded fund that rises when Wall Street’s volatility index falls almost quadrupled during the 14-month period.
Instead of backing down, the former head of global equity proprietary trading at JPMorgan Chase & Co. — who oversees about $1.2 billion — is sticking with his wager that turmoil is just around the corner.
Investors are mispricing volatility, particularly in equities, according to Barry Thomas, head of marketing at Zug, Switzerland-based Argentiere. He pointed to geopolitical uncertainties flaring up from North Korea to Syria, commodity prices fluctuating, China cleaning up its leveraged financial system and the Federal Reserve beginning to wind down its $4.5 trillion balance sheet as factors that could spark market turmoil.
“The low-volatility environment can still continue for a while, but it feels unlikely that it can continue to fall much below where it is right now,” Thomas said in an interview. “The downside risk is very limited at these levels compared with what it was a year ago.”
Long-volatility strategies, or bets that stock turbulence would resurface, have soured as the CBOE Volatility Index kept grinding lower amid a market rally. Optimism that Donald Trump’s policy agenda would lead to faster economic growth and fading concerns over populism after the election of Emmanuel Macron in France pushed the VIX down 30 percent in 2017 through Friday, following two straight years of declines. The index is about 35 percent below its five-year average and hit a decade-low this month.
Argentiere has faced “the toughest imaginable environment for a long-volatility strategy,” Thomas said. “The steady and dramatic decline in equity volatility over the last year has been a constant headwind.” Gulati wasn’t available for an interview.
Bank of America Merrill Lynch’s Global Financial Stress Index, a cross-market gauge tracking risk, hedging demand and investor flows, has been negative for more than a month, the longest streak since 2014.
The lack of asset-price swings is partly driven by short-volatility sellers, who are emboldened by expectations of quantitative easing by central banks when any crisis arises. And unlike Argentiere, some investors are betting that volatility is likely to remain muted. As turmoil rose earlier this month, an ETF that climbs when VIX short-term futures fall received its biggest inflows since August 2015 in the five days ended May 19.
“That has been a very profitable strategy over the last year, but in our view the risk-reward of selling volatility at all-time low levels is extremely poor,” Thomas said.
Funds like Gulati’s can win big as turmoil erupts. When the VIX rebounded earlier this month, an exchange-traded note that benefits when the index rises rallied 18 percent in one day. It’s since erased the gains and trades at a record low.
Argentiere, named after a skiing village in the French Alps, lost 3.4 percent in the first four months of this year after declining 7.3 percent in 2016, according to an investor letter seen by Bloomberg News. The HFRI Fund Weighted Composite Index gained 3.1 percent through April this year, while the S&P 500 Index advanced 7.2 percent with dividends reinvested.
Gulati’s fund, which initially raised about $300 million, stopped taking fresh investments in April last year after amassing $2.4 billion. Assets have since declined as investors pulled out. Thomas declined to comment on fund performance and assets.
Hedge funds betting on greater volatility have seen their combined assets decline to $6.7 billion at the end of April from $7.3 billion as of Dec. 31, according to data compiled by Eurekahedge. Those predicting a fall in price swings have seen their assets rise about 5 percent to $10 billion during the period, the data show.
“The current environment justifies more than ever to invest in long-volatility funds,” said Nicolas Roth, co-head of alternative assets at Geneva-based Reyl & Cie. “Hedge-fund investors are significantly positive this year, and an allocation to long-volatility strategies in a risk-controlled manner is unlikely to detract from their performance and will prove beneficial if — or when — the market turns south.”