Hedge Funds Trading Euro Misery?

Katya Wachtel of Reuters reports, Hedge funds find ways to trade euro misery:

Two decades ago, George Soros rose to fame and fortune on his now-historic trade in which he took on the Bank of England and shrewdly wagered on a devaluation of the British pound.

But it's unlikely the current European monetary crisis and worries about Greece's potential exit from the euro zone will give rise to an investing legend like Soros, who made $1 billion in 1992 by betting on a decline in the price of the pound.

Instead, there are a multitude of strategies to play Europe's troubles, and many different participants, hedge fund managers say.

"There is not room for one player to have such impact," said John Brynjolfsson, whose California-based Armored Wolf hedge fund has been betting against the euro for quite some time. "Financial markets are so much bigger today."

A spokesman for Soros, who last year converted his Soros Fund Management to a family office and stopped managing money for outside investors, could not be reached for comment.

The euro zone crisis has gone on for so long it is difficult for investors to pinpoint an entry and exit point for a trading strategy. Positions and hedges require constant adjustment, making it difficult to come up with a single big-winning trade.

"It's unlikely in Europe, because the way Europe works is incremental crisis, incremental recovery," London-based Robert Marquardt, founder of fund of hedge funds firm Signet, said.

Brynjolfsson and several other U.S. money managers who are trying to profit from Europe's misery say they expect the current crisis to produce a lot of winners.

So far this year, the euro is down 3.3 percent against the U.S. dollar.

Money managers say it's hard to swing for the fences the way Soros did because institutional investors are far more squeamish about having too much money riding on any single trade.

There is also heightened sensitivity from pensions and endowments about taking up an investment strategy that might spark political outrage from European leaders.

Another thing working against the rise of a new Soros is that trading the euro zone, or even the fallout from a Greek exit, is much more complicated than betting against a single currency.

Money managers are trading the euro zone crisis by trading currencies, wagering on the direction of bank stocks or using derivatives like credit default swaps to bet on potential corporate and bank failures.

Greenlight Capital's David Einhorn recently said he is bullish on gold and gold miners, in part because of concern about the fallout from a euro zone meltdown.

Some managers are even going both short and long on different European sovereign debt, depending on their views of the financial stability of different countries.

Adam Fisher, manager of the $320 million Commonwealth Opportunity Capital hedge fund, noted that Soros faced a "single country, not 17 different countries, one decision maker, not 17."

Fisher's fund, which has more than 80 percent of its money invested in Europe, is taking a somewhat contrarian position by owning the European sovereign debt of Germany, the Netherlands, Italy and Spain.

TRADING GREECE'S EXIT

Hedge fund managers point out that given the up-and-down nature of the euro zone crisis, most hedge funds have been in and out of trades or forced to adjust positions depending on the changing political winds.

Earlier this year, for instance, it looked like concern about Greece exiting the euro had passed. But with the recent results of the Greek election at odds with the austerity measures demanded by its currency partners, the risk of a Greek departure from the euro zone has risen dramatically.

Recently, Fisher said his Los Angeles-based fund had reduced the size of some of its more bullish sovereign debt trades because he believes there will be "violent" market swings this summer.

"It is going to be incredibly difficult to manage risk through that environment," said Fisher, whose fund was up 8.8 percent through April. "I don't think hedging will do anything. The way you hedge, is you sell. You don't subtract risk by adding risk."

One way to profit from any greater swings in markets would be to play the spread between European and U.S. volatility indexes, Barclays Capital equity-linked strategists say. The European index should rise faster than the U.S. one.

Brynjolfsson, a former top portfolio manager for bond mutual fund firm Pacific Investment Management Co, is betting on Greece exiting the euro. He said it will be hard for European leaders to take the necessary steps to appease the Greek government without infuriating politicians in other euro zone countries.

"As the wheels began falling off the bus, we adjusted to have a short bias and that has worked out," said Brynjolfsson, whose $750 million hedge fund is up 2 percent this year, largely on its short bet against the euro.

Some managers are even preparing for the possibility other countries will exit the euro zone.

One such trade involves taking a long position in Italian government debt denominated in U.S. dollars, and a corresponding short position in the debt denominated in euros, one hedge fund investor familiar with the strategy said. The belief is that if Italy is forced out of the euro - or the threat of that possibility grows - the U.S. dollar denominated portion will outperform.

Axel Merk, president and chief executive officer of Merk Investments, an investment advisory firm that specializes in currencies, said the growing problems with Greece and the euro zone led him recently to dump all the euros in his $517 million Merk Hard Currency Fund, which is up 2.29 percent for the year.

Merk now favors the Singapore dollar, which has climbed 1.34 percent since January.

Ray Dalio's $120 billion Bridgewater Associates gained 23 percent in 2011 in part because of profits made from a series of European bets, said a person familiar with the Westport, Conn.-based fund, who declined to discuss specifics. In a recent interview with Barron's, Dalio said European banks "are now over-leveraged and can't expand their balance sheets" and European nations "don't have enough buyers of their debt."

Dalio may be the U.S. money manager who comes closest to rivaling the Soros of two decades ago. His hedge fund is the industry's largest and he is widely regarded as one of the most successful managers.

RELATIVE VALUE

Among the ways funds are playing the European turmoil, some are betting against the fortunes of Spanish and Italian banks instead of simply focusing on sovereign debt.

John Paulson, among others, bets against European sovereign debt as a way to hedge the overall portfolio of his Paulson & Co hedge fund firm.

Daniel Loeb's Third Point fund put on a long position in Portuguese sovereign bonds in the first quarter because the New York-based manager believed the nation is in better shape than others in the euro zone.

"Portugal's debt profile is more consistent with Italy's than Greece's, its banks are substantially healthier than Spain's, and its government has enacted more aggressive labor reforms and is more stable than regimes in both countries," Loeb wrote in a May 16 investors' letter seen by Reuters.

So-called relative value trading - which involves trying to profit from a mispricing between a pair of related securities - has proved popular in this crisis as managers refrain from directional bets, prime brokers and hedge funds say.

Firms such as Boaz Weinstein's New-York-based Saba Capital and Yan Huo's London-based Capula Investment Management are among the shrewdest names in the sector, with both funds performing well amid market turmoil.

"The thing about Europe is that everything you want to do is a relative value trade. A month from now Greece could be out of Europe, or everything could be OK, you just don't know, so you have to be on both sides of the trade," Signet's Marquardt said.

If nothing else, the European crisis is forcing managers to keep coming up with new strategies to trade. One might say it has almost become an incubator for hedge fund managers to stretch their investment acumen.

Merk said he might look again at Europe if the political and financial situation becomes clearer. But he would likely do it a bit differently.

"If there is clarity in the process again, then we will certainly look at Europe again," he said. "But not through Greek debt, but through German bills."

As I stated in my last comment on anti-austerity winds blowing across the eurozone, I believe Chancelor Merkel will find herself increasingly isolated with her stance on austerity, growth and eurobonds.

As for Europe, the most crowded trade right now is short Euro shares and the euro. With bearish sentiment at extremes, any positive news will propel both higher. Reuters reports European stocks rose for a third straight session on Monday and the euro bounced back from two-year lows, as Greek polls showing growing support for pro-bailout parties eased speculation about a disorderly exit by Athens from the single currency.

I think investors are looking beyond Grexit, openly questioning whether the hysteria surrounding a possible implosion in Europe is way overdone. To be sure, Grexit will kill the global recovery, but this is why smart money is betting against the likelihood of such a doomsday scenario.

Below, Laura Fitzsimmons, VP, Futures & Options, JPMorgan Investment Bank says investors should be short riskier assets like currencies and equities and wait for a short-term bounce to ride out the uncertainty. I disagree and think now is the time for smart money, especially long-term investors, to pounce on risk assets.

If you really want to know how top hedge funds are trading in these markets, you need to read my next comment on what top funds were buying and selling in the first quarter. I believe that in this Risk ON/ Risk OFF schizoid market dominated by high frequency computers trading off the latest macro news in Europe and elsewhere, the best approach is to selectively start taking risk again in financials, tech, commodities and energy. Forget euro misery, start thinking euro jubilation!