Despite volatility hitting record lows and no signs of an imminent pick-up, it is time to target businesses which rely on volatility to drive trading volumes.
That is according to SYZ Asset Management's head of European equities, Michael Clements, who is zeroing in on financial trading firms.
Clements and senior analyst Pras Jeyanandhan said low volatility and demanding stock valuations has led them to look at where they can add volatility.
In the search for out-of-favour businesses, financials are a good entry point, he said. Clements particularly focusses on pure trading businesses including exchanges, market makers and inter-dealer brokers.
Clements said their strong returns and high levels of cash generation with exposure to volatility-driven trading activity positions makes these businesses among the most attractive at the moment.
Leading provider in spread betting and CFD products IG Group is one stock he is keeping a close eye on, as he said it is generally geared to volatility in the short term.
‘While regulation is a key risk, IG is best positioned to adapt to the changing environment at the expense of smaller players.’
Eyes on ETFs
Another strong volatility bet is Flow Traders, the leading ETF market maker, which has around 20% of market share in Europe, he said.
At present, the firm’s earnings are depressed and shares have been weak as a result of the lack of volatility but, he said, there could be a significant upside if volatility were to return to normal levels.
‘Over the longer term, it is benefitting from the structural growth in ETFs, but in the short term its revenues are largely influenced by volatility.
‘When this is subdued, low trading volumes and tight spreads weigh on revenues. However in times of stress or market dislocation, volatility provides a kicker to its structural revenue growth.’
‘While we have little or no visibility as to when volatility will pick up, we feel that over our long term time horizon it will normalise to the benefit of companies like Flow Traders or IG Group.’
While many financials rely on volatility, the contrarian manager steers clear of investment banks, which do not meet SYZ AM’s quality criteria.
‘There are simply too many balance sheet risks including high levels of leverage and opaque hard to value balance sheets. In times of stress and volatile markets, we feel these would be particularly risky investments,’ he said.