Merrill Lynch Global Research is rolling out a new index with exposure to equity volatility called the Merrill Lynch U.S. Forward Equity Variance Rolling (FEVR) Index. The index measures the performance of a long S&P 500 volatility strategy designed to be both tradable and efficient. Because of the tendency of volatility to strengthen when equity markets weaken, volatility can serve as an alternative to standard equity portfolio hedges, such as put options.
The ML U.S. FEVR Index is designed to efficiently track volatility using a strategy designed to minimize the carry cost associated with owning volatility, while attempting to capture many of the important benefits that a long volatility strategy provides. Merrill Lynch Global Research has found that over the past two decades an allocation of 25 percent FEVR and 75 percent S&P 500 would have generated the highest returns per unit of risk. Such allocation leveraged to the same risk level as the S&P 500 would have outperformed a long-only equity investment. "Given the high negative correlation to equities, considering volatility as an asset class and integrating it into a portfolio could help to significantly reduce overall portfolio risk," says Heiko Ebens, head of Equity Derivatives Research at Merrill Lynch. "Moreover, volatility can provide equity investors with protection when they most need it, during periods when markets are declining sharply," he adds.