The investment banking arm of Barclays Bank is tapping into what it sees as investor desire to mitigate market gyrations via products which profit from volatility in US and European equities.

Barclays Capital yesterday told journalists what it sees as the merits of getting exposure to implied equity market volatility via exchange-based notes (ETNs) marketed under its iPath brand. These notes, which are debt securities issued by UK-listed Barclays Bank, pay a return based on short and medium-term performance, via futures contracts, of indices such as the US VIX Index. This index measures implied volatility in the benchmark US S&P 500 index of equities. Barcap also has ETNs which mimic returns from the EuroSTOXX 50 index, which like the VIX tracks implied volatility among blue-chip European stocks.

Natasha Jhunjhunwala, of the Barclays Capital equity & funds structured markets division, talked about how investors can offset problems caused by choppy markets by the use of ETNs. The market in such instruments has become increasingly accessible to retail investors since the early days of listed options in the 1970s, when the market was a purely professional affair for institutions.

“For it [volatility] to be treated as an investment, it gives you something that no other asset can give you in that it does well in times of stress. It has a strong negative correlation [to the broader market], which is 90 per cent of the story,” said Jhunjhunwala.

The hunt for negatively correlated assets remains a "Holy Grail" for wealth managers, who saw how even supposedly safe haven assets such as gold – now at record highs – fell along with other markets during the 2008 financial crisis. The focus on volatility as a distinct investment area also highlights the evolution of what can be termed "alternative" investments.

Types of volatility

There are two broad forms of market volatility: a backward-looking measure, or realised volatility, which measures standard variations in a price level over a period of time. Implied volatility is the forward looking measure of volatility which aims to capture the market’s expectation for the asset’s future volatility, or uncertainty of future returns. Assets which exhibit higher volatilities generally tend to be viewed as carrying greater risk, Jhunjhunwala said.

Barclays’ ETNs are offered in short term and mid-term capacities. They can be traded rapidly like a stock and are listed on the Frankfurt and London stock exchanges. (These instruments are not principal protected and they are exposed to Barclays’ credit risk). The iPath ETNs currently carry an annual fee of 89 basis points.

These products have been launched over the past two years but are still young enough to be relatively novel products. Barclays launched the iPath S&P 500 VIX Short-Term Futures ETN, and its medium-term sister product, in December 2009. It rolled out the iPath VSTOXX Short Term Futures ETN in April 2010, and launched the iPath VSTOXX Mid-Term Futures ETN in November last year.

Turnover is robust. For example, a short-term version of the VIX ETN logged $2.8 billion in turnover on the New York Stock Exchange on 20 May, the ninth highest figure for any category of security on that exchange. Developments such as the eurozone debt crisis, the Japanese earthquake and geopolitical tensions in the Middle East and North Africa have put volatility at the centre of investors’ minds.

The European market appears to be moving away from the US market as concerns grow regarding the sovereign credit of certain European countries, said Jhunjhunwala.

Nonetheless, Barcap is confident that investment into implied volatility will be an attractive prospect in the European and American equities markets alike. Barcap argues that investment into implied volatility will be an important component in a diversified portfolio.

However, the novelty of volatility as a distinct investment area, and lingering fears stemming from the 2008 financial crisis, means some institutions remain wary, she said.

“One of the concerns we have heard in Europe, rather than in the US, is that some fund managers and asset managers have restrictions in terms of counterparty exposure,” said Jhunjhunwala, referring to the financial strength of banks which issue products such as ETNs. To meet that concern, iPath has put its mid-term European ETN inside a UCITS fund vehicle.