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Hedge Fund Bull Bets at Four-Year High After Lagging S&P 500


Date: Monday, March 7, 2011
Author: Alexis Xydias and Nikolaj Gammeltoft, Bloomberg

As gains at his hedge fund tumbled from 49 percent in 2009 to 3 percent last year, Pierre Philippon of London-based Zadig Asset Management was hearing from clients.

They wanted to know if the company, which runs the Zadig Fund that beat 91 percent of rivals since 2006 even with last year’s return, would give them a way to bet only on stock gains as the Standard & Poor’s 500 Index posted its biggest rally in five decades. He complied, loading up a new fund with companies such as CGGVeritas that benefit most from economic expansion.

“At the time, we were not keen to do it,” said Philippon, whose company oversees $650 million, including the Zadig Fund that was 10th-best in the world this year through Feb. 18 among hedge funds tracked by London-based HSBC Holdings Plc. He changed his mind as Europe’s sovereign credit crisis made shares too cheap to pass up. “Our call is valuation driven. It’s not too late to invest in equities.”

As the rally that drove the S&P 500 up 95 percent begins its third year, more hedge funds are speculating stocks will advance than at any time since 2007, according to data compiled by TrimTabs Investment Research and BarclayHedge Ltd. While money managers playing catch-up with the market’s gains have helped the benchmark index advance 5.1 percent in 2011, it also may deplete the pool of new buyers.

Rising Oil

The S&P 500 rose 0.1 percent to 1,321.15 last week after first-time claims for unemployment benefits slid to the lowest level since May 2008 and American service industries expanded at the fastest pace in five years, data from the U.S. Labor Department and the Institute for Supply Management showed. The gain was reduced on March 4 after rising oil and concern American wage growth is slowing sent the index down 0.7 percent.

March futures on the U.S. benchmark index dropped 0.2 percent to 1,318.1 as of 8:40 a.m. in London today. The Stoxx Europe 600 Index fell 0.3 percent.

Hedge funds, largely unregulated investment vehicles that aim to make money whether markets rise or fall, took advantage of record-low interest rates to increase borrowings in January to the highest level since October 2007, according to data compiled by New York-based NYSE Euronext. Margin debt peaked in March 2000 and July 2007, before the S&P 500 began a 57 percent drop that bottomed at 676.53 on March 9, 2009.

A gauge compiled by TrimTabs and BarclayHedge measuring how heavily hedge funds are invested in stocks rose to 33 percent in January, the last month data are available, from the 29 percent average since 2000. The measure peaked at 66 percent in August 2006 and bottomed at 9.5 percent in June 2007, the data show.

Shares borrowed and sold to profit from declines dropped four straight months to 3.3 percent of all stock at the end of January, according to data compiled by NYSE Euronext.

Shorting ETFs

The level of short selling in exchange-traded funds slipped to 11 percent of shares outstanding in January, the lowest level since 2001, based on data tracked by Societe Generale SA. Rebecca Cheong, an equity derivatives strategist for the Paris- based bank, said this shows hedge funds have been forced to reduce their bearish bets as the S&P 500 rallied.

“Hedge funds have been underperforming the equity market,” she said. “Therefore, they can’t afford to short the market when it rallies.”

Double Down

Zadig Fund has gained 6.6 percent in 2011, according to data compiled by Bloomberg. It’s been helped by Paris-based CGGVeritas, the world’s largest seismic surveyor of oilfields that rallied 18 percent through March 4, and Nasdaq OMX Group Inc., the New York-based exchange operator that also rose 18 percent. The fund trailed the market in 2010 after cutting investments in luxury-goods makers and emerging markets.

It’s the wrong time to double down, according to Timothy Flannery, managing partner and chief investment officer of Chicago-based Copia Capital LLC, which manages about $400 million in a hedge fund that bets on stock gains and declines.

The S&P 500 has fallen 1.6 percent from its 2011 closing high of 1,343.01 after turmoil from Libya to Bahrain pushed the price of oil above $100 a barrel in New York. The U.S. military is exploring a “full range of options” to respond to unrest in Libya, U.S. President Barack Obama said March 3.

“The U.S. stock market is underpricing geopolitical risk,” Flannery said.

Hedge funds returned 8.5 percent last year, trailing the S&P 500’s 13 percent gain, according to data compiled by Bloomberg on 2,728 funds. An investor who bought the Vanguard 500 Index Fund tracking the S&P 500 would have matched the index’s return last year while paying fees of 0.2 percent, compared with hedge funds that usually keep 20 percent of any appreciation.

Biggest Profit

The S&P 500’s rally since March 9, 2009, has produced gains last seen over a comparable period in 1955, according to data compiled by S&P. Investors trying to chase that advance will be disappointed, said Mark Freeman, who helps manage $11 billion as co-chief investment officer at Westwood Management Corp. in Dallas.

“They’re playing catch-up, and equities seem to be the asset class to do it in,” Freeman said. “You have people who feel a little more certain about things moving into the market. I’m not sure how successful an investment strategy that is. The market may already be incorporating that certainty.”

The S&P 500 has risen 26 percent since Aug. 26, the day before Federal Reserve Chairman Ben S. Bernanke said in Jackson Hole, Wyoming, that “he was willing to do everything in his power” to stimulate growth. In November, the central bank announced a $600 billion plan to buy Treasuries. The labor market has improved and companies have topped analysts’ earnings estimates for eight straight quarters with the fastest profit growth since the mid-1990s, Bloomberg data show.

Value Versus Bonds

Equities may be a bargain compared with bonds. S&P 500 earnings represent 6.45 percent of the index’s value, or 2.96 percentage points more than yields on 10-year Treasuries.

Ben Funk at Liongate Capital Management LLP is sending more money to managers who are using leverage to enhance returns. Funk started to get more bullish on equities after Bernanke’s comments in August.

“We think it’s a thankless mission to try to fight the Fed,” Funk said. He is head of research at Liongate, which runs a $3 billion fund of hedge funds in London. “To be contrarian is good, but it can be painful before it works. While we respect that the U.S. is only starting to recover and growth will be uneven, we do think that over the next two to three quarters, U.S. equities, certainly relative to credit, are very attractive.”

Net Deposits

The Liongate Multi-Strategy Fund rebounded from losses between January and August 2010 to gain an average of 2 percent in each of the last four months last year, according to investor documents obtained by Bloomberg. That gave it an annual rise of 4.9 percent, less than half the S&P 500’s gain.

Hedge funds received net deposits of $10.9 billion in January, according to Chicago-based HedgeFund.net. Assets rose 0.7 percent in January to $2.5 trillion, the firm said in a Feb. 28 report. They remain 18 percent below record levels in the second quarter of 2008.

Investors using futures contracts to speculate on stocks are snapping up technology makers and smaller U.S. companies at a rate that is close to the most bullish in five years. Large speculators’ futures positions on the Nasdaq-100 Index are higher than they’ve been for 86 percent of the time since 2006, according to data compiled by BNP Paribas SA.

Futures on mid-size companies in the S&P MidCap 400 Index and small-cap companies in the Russell 2000 Index have only been more bullish 26 percent and 17 percent of the time.

“U.S. equities are the best investment opportunity there is from a global perspective,” said Timothy Ghriskey, chief investment officer at Solaris Asset Management in Bedford Hills, New York, which manages $2 billion. “The biggest risk to this is complacency and the perception that everything is great. We don’t think we’re there yet. There’s certainly a new wall of worry to climb with the events in the Middle East, but the market is showing a lot of resilience.”

--With assistance from Saijel Kishan, Katherine Burton, Kelly Bit and Jeff Kearns in New York and Jesse Westbrook in London. Editors: Chris Nagi, Nick Baker

To contact the reporters on this story: Alexis Xydias in London at axydias@bloomberg.net; Nikolaj Gammeltoft in New York at ngammeltoft@bloomberg.net