According to new Merrill Lynch research, hedge funds are finding it harder to take profits from equities because dwindling volatility and gr...

According to new Merrill Lynch research, hedge funds are finding it harder to take profits from equities because dwindling volatility and growing efficiency have reduced opportunities.

Many hedge funds specialising in equities rely on what they consider to be market mispricing and assume that prices will return to their long-term levels. Volatility, and hence potential examples of mispricing, have reduced significantly, and this, along with large money flows into these strategies have made it difficult to deliver returns.

A benchmark measure of US stock market volatility, the Chicago Board Options Exchange's Market Volatility Index, has mostly held below the 20 per cent level for most of the past 12 months. During the six years to April 2004, this indexed averaged between 20 and 30 per cent, with several spikes above 40 per cent.

"Market-implied volatility is likely mean-reverting back to the old trading bands, fluctuating generally between 20 and 10," said the Merrill research.

Low volatility means mispriced stocks are not as common a phenomenon as they were a few years ago.