Betting correctly on volatility drives hedge fund profits—but have European debt markets been too skittish for even hedge funds to touch? Default drama in Greece and Italy rivaled that of a telenovela, and the shining knight who rode in on a >$600B European Central Bank (ECB) bailout did little to save the distressed damsel in the eyes of the market. Even more concerning to fund managers is the anomalous behavior of investment structures like certain relative value trades that have paid off in the past, but are unpredictable in the current environment. So, what are hedge funds really doing after a tumultuous Q4?
Not staying away, apparently—at least some of them aren’t. Despite uncommon volatility in market sectors that bet on risk alone, plenty of funds have risen to the surface, caught their breath, and taken a second plunge. And while sanctions for certain Eurozone investment structures have been placed upon European fund managers, no such limitations have been made for U.S. funds. But, while some fund managers are diving back down toward the risk, others are pessimistic about Europe’s prospects. Take a look at what a few fund managers have to say:
Saba Capital Management
Boaz Weinstein, founder of the $4.2B investment firm, Saba Capital Management, is a self-reportedly confident investor in Greece’s sovereign debt. “[Banks] haven’t come clean on the value of Greek debt that they’re holding,” said Weinstein on a September Bloomberg expert panel. “There are plenty of European banks that have Greek debt marked at or near par,” he continued, citing such misleading valuations as the primary enemy of investor confidence. Saba paid $0.38 on the dollar for one-year Greek debt, which Weinstein admitted at the time had a 75% chance of default. Weinstein defended the decision on the grounds that the default risk was priced into the product.
Michael Platt, founder of BlueCrest Investments, had the opposite opinion, which he spoke of to Bloomberg TV, saying “The problem with Europe is that almost every part of it has gone wrong…The banks are undercapitalized…If banks were hedge funds, and you mark them to market properly, I would say that probably most of them are insolvent.”
Of the investment strategy of his $30B hedge fund, Platt continued with the following statement: “The main thing that’s driving our decision about where to lend money or where to place our funds under management, the vast majority is dollars which we keep in two-year notes. We have a chunk of Euros, which we keep in German two-year paper. We’re not interested in taking any peripheral debt risk at all and we’re not interested in taking any bank credit risk right now.”
That’s not to say that BlueCrest doesn’t see itself participating more fully in the European debt crisis in the future. Concluded Platt, “The major opportunities will come post-blowout.”
Hayman Capital Management
Kyle Bass, Managing Partner of Hyman Capital Management, was also bearish on the European market, predicting widespread capital flight and calling recent ECB and Eurozone government agreements a “doomsday machine”. Bass is well-known for his prescience with respect to both the sub-prime mortgage meltdown as well as the Euro debt crisis, making early bets in substantial amounts predicting a Greek default. Some analysts speculate that Hayman Capital stands to make close to “$700k per every $1,100” bet it took, saying it cost the fund only 11bps to purchase Greek CDSs.
Said Bass to CNBC of the Euro debt crisis on December 11th, “This bill is due, and nobody can pay it…the picture is so large, and the leverage in the banking system is so enormous that when you start deleveraging there is no way out of this scenario.” While some analysts thought Europe’s situation could be improved if member countries reached a better accord, Bass still believed many market-watchers weren’t framing the picture with the correct lens. “We’re talking about injecting a lot of liquidity into a solvency problem, and it’s the right thing to do, but I think the markets are reading it improperly and I think they’ll figure it out a little bit later on.”
MF Global Investments
No conversation about Euro debt and hedge funds would be complete without mention of MF Global, whose reported >$6.3B European debt exposure alone prompted the firm’s October bankruptcy filing, the 8th largest reported bankruptcy in the history of the U.S. With positions in Italian, Spanish, Portuguese, Irish and Belgian bonds nearly quadrupling between Q4 2010 and Q3 2011, MF Global’s strategies surpassed the risk tolerance for typical fund, earning former Goldman Sachs CEO and New Jersey Senator, Jon Corzine, the reputation of a “rogue trader or an egomaniac.”
However, not everybody believes that Southern European bonds are without promise. In November, Billionaire investor George Soros purchased ~$2B of MF Global’s European position to add to his family’s private portfolio at an undisclosed, but predictably favorable, price. KPMG (MF Global’s Bankruptcy Administrator) told The Wall Street Journal that the remainder of the portfolio had been liquidated within 30 days of the bankruptcy filing, indicating at least some confidence among certain investors that the Eurozone will bounce back.
Conclusion: Timing is Everything
While the aforementioned fund managers may be making longer-term bets, another set is trading in response to smaller ups and downs. “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 multi-manager business) to Reuters. “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.”
And myriad funds are trading, typically in smaller-dollar, shorter-term positions. Andrew Mann of Viognier Capital Management, for one, has admitted to turning to merger arbitrage strategies. Bruno Crastes, CEO of H2O Asset Management, has cited a redoubled interest in currency trading. “In these market conditions, if you take a long-term bet you could be wrong for a very long time,” Global Head of AXA Funds of Hedge Funds, Francisco Arcilla, agreed.