Money Managers Seek to Profit from Europe’s Woes

When Moody’s Investors Service (MCO) downgraded Ireland’s sovereign debt to junk status on July 12, a week after giving Portugal’s debt similar treatment, it came as no surprise to Sandor Steverink. Europe’s best-performing government bond fund manager over the last decade, Steverink predicted both downgrades. Soon it will be time to buy, he says. “What we’ve learned from emerging markets is that you get only a full recovery after a proper restructuring,” says Steverink, who is co-head of a team managing €26 billion ($36.4 billion) at Dutch insurer Delta Lloyd. “We think that’s necessary for Greece and, in the end, probably for Ireland and Portugal, too.”

Of the two countries, “we prefer Ireland above Portugal,” he says, because Ireland’s debt burden was caused by the banks, not by “structural problems” such as heavy government borrowing and slow growth. He believes Ireland also has more potential to export its way out of trouble. Ina Goedhart, Steverink’s colleague, says the fund would wait at least a month before buying any Portuguese debt. Why? Many investors who can’t hold the bonds now that they have been downgraded to junk status will be forced to sell, pushing their prices down, says Goedhart.

Steverink’s Delta Lloyd Institutional Obligatie has returned 5.8 percent a year since 2001, making it Europe’s best-performing euro-denominated government bond fund with more than €500 million of assets over the past 10 years, according to Morningstar (MORN). It also beat all rivals over the past three and five years.

While Steverink hopes to profit from low-rated bonds rebounding, others are betting on price declines. Nick Swenson, who runs Groveland Capital in Minneapolis, has been speculating on sovereign defaults in peripheral European countries since March 2010. His $10 million fund is buying credit-default swaps on Spanish and Italian government bonds. CDS are a type of insurance that makes investors whole if a borrower fails to pay. Even without a default, their prices can rise when the bonds they are linked to fall in value. Swenson believes CDS on Spanish and Italian government bonds offer potential for profit because they are underpriced in light of the countries’ shaky finances. “People think they aren’t at risk of defaulting,” he says. “Prices of all non-Greek bonds seem to be too optimistic.”

Olivier De Larouzière, who manages Paris-based Natixis Asset Management’s Souverains Euro fund, is betting against medium-term Spanish bonds. The market’s view of Spain is “too positive, if you consider how systemically risky the country is,” says De Larouzière. “It will be much more difficult for the institutions to deal with a Spanish crisis.”

Some hedge funds are moving beyond a direct bet that sovereign debt values will tumble, targeting potential fallout in the corporate debt market and the banking industry. They are making investments that will pay off if heavily indebted nations such as Portugal, Spain, and Italy slash spending, slowing growth and reducing discretionary consumer outlays. “Our thesis is that the bad countries can make bad corporate debt,” says Simon Finch, head of credit trading at CQS UK, a London-based hedge fund that oversees $11 billion. Finch has been trading the debt of mobile-phone companies, which he expects to suffer. “If you crimp people’s spending, you’ll find that phone calls are surprisingly discretionary,” he says.

Marathon Asset Management, a $10 billion fund run by Bruce Richards, told clients in a mid-June presentation that it’s evaluating the purchase of portfolios of $1 billion or more of real estate and corporate loans from banks in Portugal, Ireland, Spain, the U.K., and Italy that will be forced to sell debt to raise capital. Marathon, based in New York, says it has already traded more than $1 billion worth of sovereign credit in the peripheral European countries this year, using both CDS and bonds.

The bottom line: As Europe struggles to resolve its debt crisis, some money managers are betting bonds will fall even further and economies will slow.

By Katherine Burton, Kevin Crowley, Saijel Kishan, and Anchalee Worrachate

Burton is a reporter for Bloomberg News. Crowley is a reporter for Bloomberg News in London. Kishan is a reporter for Bloomberg News.Worrachate is a reporter for Bloomberg News.

Source: Business Week | Click Link

Hedge Funds Bet Europe’s $1 Trillion Bailout Won’t Solve Crisis

“The EU and the IMF effectively went all-in with a bad hand in the highest stakes game of financial poker ever played with the world,” wrote Bass, head of Dallas-based Hayman Advisors LP, in a letter to clients sent after the bailout was announced.

Bass bought gold last week and took other steps to position the fund for hyperinflation and a “competitive devaluation” by Europe, Japan and the U.S. that he is forecasting, according to the letter. Christopher Kirkpatrick, general counsel for Hayman, declined to elaborate on the comments.

Managers who made short bets on U.S. subprime securities as the housing market was imploding in 2007 and 2008 see similar opportunities in Europe, said Nick Swenson, who manages Minneapolis-based Groveland Capital LLC and profited as mortgages tumbled. In March, he started buying credit-default swaps on Spanish, Italian and Irish government bonds, a sort of insurance that pays off in the event of a default or restructuring.

“It’s asymmetric — it reminds me of the subprime trade,” he said in a telephone interview.

Yesterday, Germany said it was temporarily prohibiting naked short-selling and speculating on European government bonds with credit-default swaps. Naked short sellers bet against a security without first borrowing it.

Euro Decline

The euro tumbled to as low as $1.2159 after the pronouncement. In February, as some investors forecast that Greece might not be able to pay its debts, French Finance Minister Christine Lagarde said she wanted politicians to take a united approach against “speculators” betting on government bond defaults.

Swenson decided to buy the sovereign CDS after looking at the external-debt-to-exports ratios of the 26 countries that have defaulted on their debt since 1970. The average ratio for those countries was 2.3. As of the third quarter of 2009, Spain’s was about 6.9 and Italy’s was about 5.1, he said.

While the CDS on these bonds rose in April and have since dropped nearer to levels where he bought them, Swenson isn’t selling. He believes the chance that one of the three countries will default or restructure is greater than the 9 percent currently priced into the CDS.

Paulson Stays Out

John Paulson, who made $15 billion betting on the subprime trade, is one manager who may not be replicating the CDS trade he used three years ago. Earlier this month, in a conference call with investors, he called Europe’s debt problems “manageable.”

A weaker euro will benefit French and German exporters, he told clients. Like Bass, he’s been forecasting a jump in inflation, which is why he’s been a buyer of gold and gold producers since at least last year.

For other managers, the potential profits from betting against Europe still outweigh the costs. Swenson pays 1.3 percent annually to put on his bet against Irish, Spanish and Italian debt.

Mark Hart, who runs Fort Worth, Texas-based Corriente Advisors LLC, returned $320 million of the $424 million European Divergence Master Fund LP in February, after betting that some European governments will default on their bonds.


“The European divergence theme offers an asymmetric risk/reward profile,” Hart told clients at the time. “The sovereign debt problem in Europe is widespread and is not isolated to a single issuer.”

Hart, who also profited from bets against subprime mortgages, didn’t return a call seeking a comment.

Matrix PVE Global Credit Fund, a 110 million-euro ($133.9 million) fund run by Gennaro Pucci based in London, gained 19 percent in April because of bets that Europe’s credit crisis would worsen.

“The ECB is buying debt at artificial levels, but that won’t solve structural problems,” Pucci said in a telephone interview.

Matrix Group Ltd. manages about 3 billion pounds ($4.3 billion) including a half-dozen hedge funds. The credit fund sold most of its CDS positions in the recent jump in prices, and then put some back on at current levels.

“We’re in the aftermath of a financial crisis,” Pucci said. “It’s not unusual for sovereign debt to explode.”

By Katherine Burton and Tom Cahill

–Editor: Christian Baumgaertel, Josh Friedman