investment viewpoints

How long will convexity disappoint?

Is it time for neutral equity exposures?
François Chareyron - Portfolio Manager

François Chareyron

Portfolio Manager
Natalia Bucci - Co-head of Convertible Bonds

Natalia Bucci

Co-head of Convertible Bonds
Florian Ielpo - Head of Macro, Multi asset

Florian Ielpo

Head of Macro, Multi asset

These are uncertain times – be it regarding growth, inflation, or the extent of rate hikes. And yet, the level of one of the most common measures for volatility – the famous VIX index – has not budged much since 20 March and the end of the fast-paced banking crisis. This raises two principal questions about volatility and convexity, which we explore in this weekly edition of Simply put.


Need to know:

  • The VIX volatility index and other risk aversion markers have been at low levels for a long period of time
  • Historically, such periods rarely last more than three months – this time should be no exception
  • Convexity strategies could have their say once more in this situation, after a disappointing 2022


Volatility remains low

First, how long can these periods of low volatility be expected to last? Since the end of the regional banking crisis, about three months have elapsed without the VIX exceeding 25% (its first quartile). Analysing how long such periods last from a historical perspective seems important in answering this question. Second, if the VIX and other option-implied measures of risk finally start rising, will convex strategies benefit? We think so, and here we explain some reasons why.


It’s not just the VIX

The first question we should be asking ourselves is: how ‘normal’ is a 15% reading on the VIX? One of the ways to run a sanity check on this is to look at a cross section of so-called ‘fear’ indices – the VIX is just one of these; others credit-default-swap (CDS) spreads on different types of credit, forex volatility or liquidity indices.

Figure 1 compares the VIX index with our inverted risk appetite index. It confirms that the VIX is not alone in being sanguine: the vast majority of standard risk indicators have been flashing green since the end of the banking crisis. As with the VIX, our risk appetite index has reached a very high level by historical standards, which is reflected across its subcomponents, meaning that bullishness is widespread across markets. The data for June and July shows a positioning-driven rally across risky assets.

How long can this situation last? Earnings results means that the bottom-up outlook seems to once more be beating expectations, but the macro data are still on a downward trend. Should they rightfully indicate an increasing risk to earnings in the coming months, or if a different catalyst came to the forefront of newsflow, risk gauges such as the VIX could start rising again. Do historical patterns offer any insight into how long periods of low volatility typically last?


Figure 1. VIX vs the recent evolution of LOIM’s risk appetite index (inverted scale)

Source: Bloomberg, LOIM as at July 2023. For illustrative purposes only.


Risk appetite cycles are shorter than you think

Figure 2 attempts to an answer the question: how long can this situation last? It shows how often the VIX registered levels below 25, 20 and 15 between 1991 and 2003, expressed in months. For example, 79% of the time it has stood at 25% or under, this level persisted for less than one month. For only 9% of the time, these relatively mellow periods lasted for two months. Tranquil periods of three and six months have, historically, happened just 4% of the time.

Currently, the VIX has been below 25 for more than 80 days. This indicates that markets are defying historical patterns with greater frequency. The same conclusion arises when looking at the more conservative VIX levels of 20 and 15, further suggesting that abnormally low levels of volatility cannot last forever.

This obvious point here is that unless we are in a Goldilocks period like the mid-1990s or a 2017-like cycle, any expectation that the VIX will beat the record it set in 1997 – of being sub-25 for 1673 consecutive days – looks far-fetched. But this is not the only problem investors are faced with at the moment: convex strategies, which are supposed to cash in on surges in volatility have disappointed recently. What should they do now?


Figure 2. How long has the VIX spent below 25, 20 and 15 ?

Source: Bloomberg, LOIM as at July 2023. For illustrative purposes only.


Convexity is back

Figure 3 shows what probably caused a lot of despair among asset managers in 2022: not only did equities and bonds decline in tandem, but equity volatilityand hedging strategies largely disappointed as well. This lack of reactivity has been widely attributed to the ‘volatility down, spot down pattern’ – i.e., the fact that markets declined without volatility, preventing strategies based on implied volatility from profiting.

The chart shows the performance of a set of indexed volatility strategies, which we use in our multi-asset solutions, as a function of the level of the VIX. The regression line shows the bad news: how these strategies reacted poorly to changes in the VIX last year. The good news is that it has recently improved. For 2023, the regression line shows a better and much more natural slope. As the volatility situation normalises, volatility strategies are demonstrating a better reaction to surges in risk aversion.


Figure 3. Performance of volatility strategies as a function of the VIX’s level

Source: Bloomberg, LOIM as at July 2023. For illustrative purposes only.


Looking for higher vega

Convertible bonds could be impacted by an exposure to implied volatility. The contribution of vega – the positive sensitivity of the asset class to changes in volatility – to market returns has been rising since the end of 2021. Essentially, this has happened for two reasons: the asset class has accrued a rising share of risky growth names since the pandemic, leading to an increase in risk and volatility, and there was also a dry primary market in 2022, which supported valuations. More recently we have seen vega detracting from performance as equity-market volatility has abated (see figure 4).

Should realised volatility increase from here, it may boost the performance potential of the asset class. Higher risk, all other things being equal, means a greater sensitivity to volatility movements. Today, the asset class presents a rising average vega and, should we see in pick-up in volatility, this feature could make it attractive again.


Figure 4. Convertible bonds’ vega contribution and implied volatility

Source: Bloomberg, LOIM as at July 2023. For illustrative purposes only.


Investors should pay attention to convexity in the coming months: rising VIX levels could benefit such strategies in the second half of the year relative to the first. There is probably today a lot of vega in disguise across hedging strategies and asymmetric asset classes, and this sensitivity could emerge in H2.


Simply put, the VIX has likely been subdued for too long, driven by a widespread positive sentiment. When it rises, convexity strategies could benefit.



[1] Rates volatility strategies were effective. Past performance is not a guarantee of future results.


Macro/nowcasting corner

This section gathers the most recent evolution of our proprietary nowcasting indicators for world growth, world inflation surprises and world monetary-policy surprises. These indicators keep track of the most recent macro evolutions that make markets tick.

Key insights:

  • Our growth indicator has been changing direction: it was ‘low but rising’ recently, but this week shows a ‘low and declining’ regime. Our world growth indicator has shifted from 52% of improving data to 47%, with that decline happening across the three zones
  • Inflation surprises have remained stable this week, but the diffusion index now shows 63% of data components are rising – the inflation story is probably not over 
  • Our monetary-policy signal keeps signalling that less hawkish monetary policy is likely to come, as it remains below the 45% threshold

World growth nowcaster: long-term (left) and recent evolution (right)

World inflation nowcaster: long-term (left) and recent evolution (right)

World monetary policy nowcaster: long-term (left) and recent evolution (right)

LOIM's nowcasting indicators gather economic indicators in a point-in-time fashion to measure the probability of a given macroeconomic risk - growth, inflation and monetary policy surprises. The Nowcaster ranges from 0% (low growth, low inflation and dovish monetary policy) to 100% (high growth, high inflation and hawkish monetary policy).

important information.

For professional investor use only
This document is issued by Lombard Odier Asset Management (Europe) Limited, authorised and regulated by the Financial Conduct Authority (the “FCA”), and entered on the FCA register with registration number 515393.
Lombard Odier Investment Managers (“LOIM”) is a trade name. This document is provided for information purposes only and does not constitute an offer or a recommendation to purchase or sell any security or service. It is not intended for distribution, publication, or use in any jurisdiction where such distribution, publication, or use would be unlawful. This material does not contain personalized recommendations or advice and is not intended to substitute any professional advice on investment in financial products. Before entering into any transaction, an investor should consider carefully the suitability of a transaction to his/her particular circumstances and, where necessary, obtain independent professional advice in respect of risks, as well as any legal, regulatory, credit, tax, and accounting consequences. This document is the property of LOIM and is addressed to its recipient exclusively for their personal use. It may not be reproduced (in whole or in part), transmitted, modified, or used for any other purpose without the prior written permission of LOIM. This material contains the opinions of LOIM, as at the date of issue.
Any benchmarks/indices cited herein are provided for information purposes only. No benchmark/index is directly comparable to the investment objectives, strategy or universe of a fund. The performance of a benchmark shall not be indicative of past or future performance of any fund. It should not be assumed that the relevant fund will invest in any specific securities that comprise any index, nor should it be understood to mean that there is a correlation between such fund’s returns and any index returns.
Neither this document nor any copy thereof may be sent, taken into, or distributed in the United States of America, any of its territories or possessions or areas subject to its jurisdiction, or to or for the benefit of a United States Person. For this purpose, the term “United States Person” shall mean any citizen, national or resident of the United States of America, partnership organized or existing in any state, territory or possession of the United States of America, a corporation organized under the laws of the United States or of any state, territory or possession thereof, or any estate or trust that is subject to United States Federal income tax regardless of the source of its income.
Source of the figures: Unless otherwise stated, figures are prepared by LOIM.
Although certain information has been obtained from public sources believed to be reliable, without independent verification, we cannot guarantee its accuracy or the completeness of all information available from public sources. Views and opinions expressed are for informational purposes only and do not constitute a recommendation by LOIM to buy, sell or hold any security. Views and opinions are current as of the date of this presentation and may be subject to change. They should not be construed as investment advice.
No part of this material may be (i) copied, photocopied or duplicated in any form, by any means, or (ii) distributed to any person that is not an employee, officer, director, or authorised agent of the recipient, without Lombard Odier Asset Management (Europe) Limited prior consent. In the United Kingdom, this material is a marketing material and has been approved by Lombard Odier Asset Management (Europe) Limited which is authorized and regulated by the FCA.


© 2023 Lombard Odier IM. All rights reserved.