The rise of passive investing might be affecting the measure of short-term implied market volatility, some money managers say.
With the Chicago Board Options Exchange Volatility index, known as the VIX, hovering at the lower end of its 52-week trading range, these managers wonder if that isn't a result of the increased popularity of passive investment strategies.
"The move into passive investing has created an abnormal market environment," said Paul Price, global head of distribution for Morgan Stanley Investment Management Ltd. in London. "The rush toward low-cost, but not low-risk, investing has resulted in the stock market rising and dipping together, greatly subduing stock volatility."
John Bilton, global head multiasset strategy at J.P. Morgan Asset Management in London, said some elements of passive volatility strategies are likely having an effect on the VIX.
"Over the past 10 years or so we have seen volatility (exchange-traded funds) coming onto the market," Mr. Bilton said. "They represent a certain static period of volatility — say (a) 45- or 60-day volatility period. The VIX contracts on which these products are based have a tenor, rather like interest rate contracts," so an ETF that also has a defined period will need to be continually rebalanced by its provider. "To hold the ETF exposure constant over time, the provider may be continuously buying the second month VIX contract, and selling the front month; in turn putting downward pressure on spot VIX."
Other money managers and analysts are not so sure.
Tim Edwards, senior director, index investment strategy at S&P Dow Jones Indices in London, said there is an argument for this rationale, "but it seems early to suppose it has any truth. Some might say, the future value of the economy and its significant corporations should not rationally swing by 5% from one day to the next, up 15% this quarter and down 20% that year and so on. These are the animal spirits of (British economist John) Keynes. Now, if investors move to more stable, passive diversified exposures … then perhaps they are not following the changing winds as enthusiastically as they were before, and perhaps prices might become a little less volatile," said Mr. Edwards. However, he reiterated it is too early to say whether there is any truth in that.
And Eric Lascelles, chief economist in Toronto at RBC Global Asset Management Inc., said passive investments generally mean fewer parties are actively working to set the right price for various financial vehicles. "I suppose it could indirectly support the thesis that the VIX is mispriced because of too many passive investors," he said.
However, in practice he hasn't seen much evidence that markets are being mispriced, at least not yet, "by an excess of passive investors. And the VIX is one of the last places I'd look for problems as passive investors are not usually operating in the futures or options markets," he added.