Equity market volatility is at historical lows. Strategies that are actively betting on falling volatility have gained ground. These strategies could act as fire starters to ignite volatility. Long-term oriented risk models will cause second round effects on equity markets.

1. © 2017 Quant.Capital Management GmbH
Quicktake: Equity Markets without Risk?
Webinar, 3rd November 2017
Alexander Schroer, Ivan Mlinaric

2. 1 © 2017 Quant.Capital Management GmbH
 Quant.Capital Management (QCM) – Overview
 QCM is an independent BaFin regulated asset manager with entrepreneurial owners
 Founded in 2007 in Düsseldorf
 Currently 18 employees
 Mainly institutional clients
 Focus on quantitative strategies for
 liquid alternative investments (absolute return)
 risk management (capital preservation, portfolio insurance)
 Ability to customize all concepts according to clients‘ needs
 Assets under management of more than € 1.8 bn
 Member of the German society for alternative investments, Bundesverbandes
Alternative Investments (BAI e.V.), Bonn

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 Equity Market Volatility is at Historical Lows
Volatilitätin%Volatilitätin%
Realised Volatility Implied Volatility

4. 3 © 2017 Quant.Capital Management GmbH
 Equity Market Volatility is at Historical Lows
Volatilitätin%Volatilitätin%
Realised Volatility Implied Volatility

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 Betting on Falling Volatility – Are You In?
 Performance of the VelocityShares Daily Inverse VIXShort Term ETN
 Some estimates say that up to USD 5 bn are invested in this type of strategy

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 The four largest products *) managing short strategies on VIX futures have combined
assets under management of approx. USD 2.5 bn
 When the value of VIX futures rises, these products have to close out positions on the
same day, i.e. they have to buy futures contracts
 This linear relationship can quickly lead to a strong buying pressure pushing the VIX
future up in price
 The Short Vol Trade Contains Serious Risks
*) These products are so-called ETNs („Exchange Traded Notes“), a form of unsecured debt security similar to certificates
3 points 6 points 10 points
As of 01.11.17:
VIX Future 11,50 14,50 17,50 21,50
Drawdown in % 26% 52% 87%
Contracts that have to be bought 87.015 144.195 195.614
Avg. daily volume last 3M 212.762 212.762 212.762
Share of daily volume 41% 68% 92%
VIX future rising by
Performance Scenario

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 Many investors interpret low implied volatilities as a sign of low risk. But beware!
 This does not hold true for the Short Vol Trade. There, the lower the volatility level is,
the more painful an increase in volatility becomes.
 Low Volatility Means High Risk for Short Vol Traders !

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“Not suited for Long term investment:
The long term expected value of your ETNs is zero. If you hold your ETNs as a long
term investment, it is likely that you will lose all or a substantial portion of your
investment.” *)
 Low Vol: A Sound Long-Term Investment?
*) Excerpt from the prospectus of one of the largest Short Vol ETNs on the market

9. 8 © 2017 Quant.Capital Management GmbH
Risk management
$ ?? bn
 An Enormous Volume Would Be Affected by Rising Volatilities
 There are many products that mechanically increase their risk positions when
volatilities sink and vice versa
Volatility
Risk exposure
Risk based portfolio
allocation
(Risk Parity)
$ 600 bn
Trend
followers
$ 175 bn
Target Vol
strategies
$ 400 bn
Options
strategies
$ 45 bn
Risk premia
(Low Volatility)
$ 250 bn
Source: Artemis Capital Management

10. 9 © 2017 Quant.Capital Management GmbH
 Contagion Effects Threatening From Volatility Disruptions
Shock
Rising implied volatility
Volatility
Risk exposure
„Short Squeeze“ for
volatilty sellers
Uncertainty!
Up pressure on
volatility futures
and options
Down pressure on
Risk assets
Rising realised
volatility

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 Standard Risk Models Are Not Very Adaptive to Sudden
Changes in Risk Regimes

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 Summary
1. Equity market volatility is at historical lows. From our perspective, these are extreme
values that will not persist. Volatility is bound to normalize in the future.
2. Strategies that are actively betting on falling volatilities have massively gained in
importance. These strategies can act as “fire accelerants” for volatility.
3. Investment strategies that allocate risk positions based on volatilities are currently
pushing full throttle on their risk positions. If volatilities were to rise, these risk
positions would have to be divested at large scale.
4. Long-term oriented risk models will need more time before they indicate changes in
the risk regime, which will result in initial losses accumulating for those affected
investors and consequently lead to second-round effects in the markets.

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 Conclusions
1. Currently, the sun is shining on equity markets.
2. Based on our observations, we believe that equity markets are highly susceptible to
concentrated, self-enforcing market corrections.
3. Portfolio insurance is currently available at extremely low cost. Take advantage of
this time to prepare your portfolios for the risky times ahead.
4. Make sure to get portfolio insurance that is highly reactive.

14. 13 © 2017 Quant.Capital Management GmbH
 Contact
Rainer Ottemann
Director
Tel: +49 211 6355 12 75
ROttemann@quantcapital.de
Thorsten Dierich
Director
Tel: +49 211 6355 12 70
Mobile: +49 160 968 922 57
TDierich@quantcapital.de
Alexander Schroer, CFA
Head of Portfolio Management
Tel: +49 211 6355 12 14
ASchroer@quantcapital.de
Ivan Mlinaric
Managing Director
Tel: +49 211 6355 12 11
IMlinaric@quantcapital.de

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