Hedge funds profit from quick bets in Europe crisis

Date: Tuesday, October 4, 2011
Author: Laurence Fletcher and Tommy Wilkes, Reuters

Nimble hedge funds taking short-term bets are reaping the biggest profits from Europe's debt crisis, as markets lurching on one policymaker's comments to the next punish managers brave enough to take long-term positions on the eventual outcome.

As the Euro zone's debt crisis deepens -- stocks fell again on Monday on news Greece will miss deficit targets -- investors who expect quick-thinking funds to snap up bargains in the sell-off or profit from short-selling may be disappointed.

"The smart money is not trying to predict the endgame. If you hang on, you can get a volatile position, your risk-management stops you out and you get a loss," said Luke Ellis, head of Man Group's (EMG.L) multi-manager business.

The extent of the volatility since August, and the speed with which sentiment can change, has left funds down 8.2 percent in 2011, according to Hedge Fund Research's HFRX index, with those making bold bets on how the crisis will end hardest hit.

"While you worry about the long-term, the short-term can kill you ... The smart money is using the swings and roundabouts of political debate to get into and out of trades," Ellis said.

He cited one manager who, while bearish on equities, closed out his short and bought tier one bank credit because investors had turned so negative on banks. Some funds also picked up Bank of America Merrill Lynch (BAC.N) bonds after heavy falls, one executive said.

Funds betting on volatility or currencies, or those able to find price discrepancies between bonds and stocks -- so-called relative value trades -- are among those faring best in recent months, as have funds who took bets off the table, insiders say.

In contrast, many of those taking a view on the fundamental value of securities are suffering. Strategies run by Lansdowne Partners and Crispin Odey, for example, are down this year after long-standing stock bets hurt them.

Part of the problem is just how nervous markets are. While the pan-European FTSEurofirst 300 .FTEU3 index has fallen by a fifth in 2011, 3 or 4 percent daily index moves are now common.

And despite the weakening economic climate in Europe, the euro has proved difficult to trade. The single currency is down only slightly against the U.S. dollar in 2011, though it has fallen sharply since the start of August.

"In these market conditions, if you take a long-term bet you could be wrong for a very long time," said Francisco Arcilla, Global Head of AXA Funds of Hedge Funds. "(Investor) tolerance (for a fund) to be wrong for a very long time isn't there."

RELATIVE VALUE

One area proving profitable for some managers is relative value trading.

These funds bet one security is mispriced against another, though even here caution is required when macro headlines and not fundamentals move markets -- a factor blamed by Man Group's CEO for recent losses by some GLG funds.

For instance, some equity managers suffered in August when they tried to hedge a long position that was falling with a short position in the same sector, only for market volatility to turn both positions against them.

Andrew Mann, chief investment officer at Viognier Capital Management, exited his long-short and quantitative equity positions in August after any sense of trading normality vanished, instead turning to merger arbitrage strategies.

"A whole load of equity managers haven't become bad overnight," he said.

"If there isn't enough stability and persistence within the market itself it's very difficult to invest or trade to make consistent gains. You find yourself a hero for three days and then on the fourth day it's back to square one."

But bets on a company's equities against its bonds have yielded profits as both securities tend to rise or fall together in the market volatility, said one industry executive.

And playing one currency against another may also make money, like carry trades which borrow euros or Swiss francs to buy emerging market currencies.

Bruno Crastes, chief executive of H2O Asset Management, is betting commodity currencies such as the Australian dollar are expensive compared with the Korean won or Mexican peso.

CDS

Contrary to market rumors, few funds are shorting banks, in part because of the recent ban in Italy, France, Spain and Belgium, but also because a sudden political move could send battered bank shares soaring.

A small number have bet on Greek bonds -- Boaz Weinstein's Saba Capital is among a limited number of funds to have made gains this year.

Others, although again not in large numbers, have bet on Italian and French sovereign credit default swaps as a proxy to bet the crisis is intensifying but will not end in disaster.

Tim Haywood, who runs hedge fund strategies at GAM (GAMH.S), said he saw profits in buying German bunds and simultaneously selling protection against Italian debt default, reflecting his view that as bad as things get, Europe's monetary union would not disintegrate.

"If absolute return is about making money, not losing money and giving customer's money back promptly -- then the bund and CDS combination yields more, may make more money in a crisis, and is probably more liquid in a risk-off phase."

Despite the tough trading environment, some managers are hoping the European sell-off is nearing its end, providing much-needed relief for the sector.

"Our view is that October will be a key month for the euro zone crisis and finally the PSI (private sector involvement) for Greece will take place,... which should give the market a bit of a lift," said H2O's Crastes, who favors European equities.