Hedge funds spot opportunities in Poland sell-off

Date: Wednesday, July 17, 2013
Author: Dagmara Leszkowicz and Laurence Fletcher, Reuters

- Hedge funds are betting against Poland's sovereign bonds and currency, taking advantage of a sell-off in emerging markets and slowing domestic growth to target a country that has been a top pick for foreign investors.

The European Union's biggest ex-communist country has been viewed by many investors in recent years as the star of the new EU members, with 10-year bond yields - the most popular paper among foreigners - roughly halving since joining the bloc in 2004.

But in early May it was hit by an emerging market sell-off driven by concerns about the U.S. central bank winding down its easy money policies and a slowdown in Chinese growth. Slower Polish growth also contributed to sending the zloty lower and yields higher.

Some hedge funds are betting the situation will deteriorate.

"I don't like the zloty at all. In the hedge fund we're short," said Andy Seaman, partner at London-based Stratton Street Capital, which has $2 billion under management across its portfolios.

"Poland has borrowed in order to finance current account deficits in the past, so it has to attract money from abroad."

Funds have also been betting against the bonds.

The amount of Polish sovereign bonds out on loan is up 64 percent between May 30 and July 4, not far from the year high seen in late June, according to figures from data group Markit.

This can indicate short-selling by funds anticipating a drop in price, although bonds can also be borrowed by institutions wanting to hold sovereign debt as collateral.

While comparable data for emerging markets is limited, the rebound in Polish bonds out on loan since May 30 is greater than in Hungary, Slovakia and Ukraine. It lags the Czech Republic where the central bank has said it could intervene to weaken the crown and where the number of bonds out on loan has more than doubled over the same period.

"UNWINDING"

According to research by Morgan Stanley, Poland ranks second after Mexico in a list of countries that have received the highest inflows into their government bonds since the second quarter of 2009 as a share of GDP.

The finance ministry's data show that foreign investors' bond holdings have been rising steadily in the past months to hit a record high of 207 billion zlotys ($62.25 billion) at the end of April, a move that helped the zloty remain stable for a nearly a year.

But Poland's bonds and the currency, like other emerging market assets, have been hit hard by concerns over how soon the U.S. Federal Reserve will begin reducing its stimulus programme, which sent their yields to record-lows just a month ago.

As a result, Poland's 10-year bond yield rose as much as 150 basis points in just a month, although it has since fallen from those levels, while the zloty lost nearly 5 percent against the euro, leading the region's asset falls.

Poland's economy - so far the most resilient across Europe - has also begun to slow sharply last year, barely growing in the first quarter of 2013.

John Malloy, head of research at Miami-based Everest Capital says that Poland's currency, like the Mexican peso, is facing a medium-term 'readjustment'.

"In all or most emerging market currencies that are free-floating there's an unwinding of money that flowed in looking for a carry trade," Malloy said.

"We're negative in the medium term (on both currencies)."

Not all the recent bets against European economies have worked out.

Some investors were hit after betting against Hungary, believing prices didn't reflect its economic and political outlook, only to see 10-year yields drop from 6.5 percent in late March to below 5 percent in the middle of May, although they have since risen from that level.

And many funds gave up on bets against French bonds late last year as the European Central Bank's pledge to save the euro drove yields ever lower, despite concerns about France's economic competitiveness.

OFFICIALS RELAXED

Polish officials are sanguine about the situation.

"We have noticed portfolio capital outflow from Poland but not a significant one," Poland's Central Bank Governor Marek Belka said.

"We are witnessing a normalisation of Poland's bonds' curve. Everything points to a normalisation of the situation (on the market)."

With around 90 percent of Poland's borrowing needs met already by the end of July, it can afford to trim supply significantly in the second half of the year, giving its debt market a breathing space.

Market watchers say the rise in bond yields may not be over yet as the sell-off so far has happened mainly on derivatives, not real bonds.

"If you want to see the glass half full - real money is still sitting on its bonds, thinking that the selloff is temporary," said Bartosz Pawlowski, London-based strategist at BNP Paribas.

"But if you want to see a glass smashed - if they start selling bonds, the second round begins and there will be no mercy (for Poland's debt)."