Falling volatility could lead to a reassessment of investment strategies, says Morgan Stanley

Investors may have to rethink their investment strategies if credit and equity market volatility continues to fall, according to research by Morgan Stanley.

While reduced levels of volatility in credit and equity markets have generally been welcomed by core fixed-income investors, others were not necessarily positioned for it, said the bank in its latest Credit Derivatives Insights report called Positioning a View on Volatility.

“Given the explosive growth in long/short hedge funds and the large number of outstanding convertible arbitrage and market-neutral funds, there are a significant number of investors in the market today whose business plans are dependent on reasonably high levels of market volatility,” said Morgan Stanley. These investors are under-performing the hedge fund market as a whole and the S&P 500 benchmark equity index, added the bank.

Morgan Stanley recommends that investors that wish to make money in a low-volatility world, and can use leverage or collateralised debt obligation (CDO) products, should opt to invest in subordinate tranches of cash or synthetic CDOs. “For those who cannot step down so far, senior tranches will work as well,” said the report.