Merrill Lynch introduced the Equity Volatility Arbitrage index, the first in a series of synthetic hedge fund indexes, said Carrie Gray, spokeswoman. The index aims to replicate the returns of active S&P 500 volatility arbitrage hedge funds without active management fees. It uses strategies similar to those used by active hedge fund managers in this area but relies on passive or "mechanical" rules, rather than active management, according to a research report from the company.
"Using rules to avoid the cost of active hedge fund management is the same principle that helped passive index funds (such as ETFs) gain market share from actively managed mutual funds. Additional distinct benefits of this style of investing are complete transparency and the elimination of both style drift and manager risk," Heiko Ebens, head of Merrill Lynch's Americas Equity Derivatives Research team, said in a news release.
The index arbitrages the volatility premium of S&P 500 index options using a three-month S&P 500 variance swap, said the report's authors. In historical simulations, the index outperformed most major global investible and non-investible hedge fund indexes, with negative returns in only three quarters over the 18 years ended Feb. 2, according to the research report.