Model-driven hedge funds among losers in SNB shock

Date: Wednesday, September 7, 2011
Author: Gertrude Chavez-Dreyfuss and Laurence Fletcher, Reuters

Hedge funds, betting on global markets and driven by computer models, were among those hardest hit by Switzerland's shock intervention on Tuesday to reverse profitable bets on the Swiss franc's "safe-haven" status.

The Swiss National Bank surprised investors with an exchange rate cap, saying it would no longer tolerate a rate below 1.20 francs per euro and would defend the target by buying other currencies in unlimited quantities.

The news sent the franc tumbling nearly 10 percent against the euro on trading platform EBS. In late trading, the euro was still up 8.7 percent against the franc on the day to change hands at 1.2047.

John Taylor, chairman and chief investment officer of the $8 billion currency hedge fund FX Concepts in New York, was able to get the direction right as his fund sold the Swiss franc last week. But he was hit by the sharp drop in the euro/Swiss franc volatility in the options market.

"We made money on the outrights because we were short Swiss francs, but because vols were so high, we were happily pocketing the premium for a while and that cost us a bunch of money today because volatility dropped," Taylor said.

"So net-net, our fund is down," Taylor added.

One-month implied volatilities -- a measure of the market's view of the extent of future currency movements -- in the euro/Swiss franc dropped to 9.95 percent on Tuesday from 22 percent on Monday. Vols hit a record high of around 30 percent in early August.

Overall, the FX Concepts chairman thinks 1.20 francs is a feasible entry level to buy the Swiss currency against the euro, especially if the euro zone's sovereign debt situation worsens.

Managed futures funds, which latch onto market trends and which have been among the few winning hedge funds strategies in a tough 2011, had hopped on board the franc's appreciation from more than 1.32 per euro in April to just above parity last month.

"Obviously, any directional fund will be down today," said Axel Merk, who manages the $750 million Merk Hard Currency Fund in Palo Alto, California.

Merk lost after the SNB move since he had a 1.5 percent exposure on the Swiss franc in his portfolio, but he said he managed to offset those losses by buying the Norwegian crown. In fact, Merk said he bought more crowns last Friday.

The Norwegian crown gained 1.2 percent against the euro on Tuesday.

The SNB move notwithstanding, Merk said he will still buy the Swiss franc, although it may be too early to purchase it right now since the central bank has obvious political backing to implement its target.

"But at some point, I will definitely buy it again since the SNB has made the Swiss franc cheaper," he said.


Some macro funds -- a strategy made famous by the likes of billionaire investor George Soros -- may have suffered after profiting this year from bets that the Swiss franc and Australian dollar will rise.

"I'm sure it will hurt," said one fund of hedge funds manager who spoke on condition of anonymity.

"It's a massive move. It doesn't have to be that big (a position in a fund) to be painful ... CTAs are highly likely to be hit by that." Commodity trading advisors, or CTAs, is another term for managed futures funds.

Among computer funds that may have been hit is Man Group's flagship $23.9 billion AHL fund. An AHL fund manager told Bloomberg Television last month it had a small bet on the franc.

Winton Capital, which manages $22.4 billion in assets and whose main fund is up nearly 8 percent so far this year, declined to comment on specific currency movements.

Man Group and Bluecrest also declined to comment.

One computer-driven fund manager, who was short the euro against the franc as the Swiss National Bank announced it was setting a minimum exchange rate target, said his fund has closed out all its positions in the Swiss franc.

"As it was a central bank move, we decided to square our positions and now have no market exposure to the Swiss franc," he said. "We have squared our position in the Swiss franc for the future because we will not be able to capture that risk in the quantitative models."

Other funds profited from the SNB move. Quaesta Capital, a $3-billion currency fund of funds in Zurich, Switzerland, said currency managers it oversees have gone short Swiss franc this week, posting the biggest outflow as well.

In an earlier interview, Pablo Frei, portfolio manager and senior market analyst at Quaesta, said their currency managers have become concerned about the Swiss franc's overvaluation against the euro.

Aviva Investors went long the New Zealand dollar versus the Swiss franc in the past few weeks and has seen an 18 percent move. It has also gone long in the Norwegian crown against the franc.

Hardeep Dogra, Currency Fund Manager at Schroder Investment Management in London, said they had been neutral on the franc.

It was "precisely because of this quandary," Dogra said. As "much as you like the currency, valuation is a problem and the central bank had been making repeated comments about its position, that it was aiming for some currency weakness."