'Black Swan' Hedge Funds Gain in Turbulent May

Article in HedgeWorld

European hedge funds betting on the fallout from unforeseen events were among a small band of winners in a stormy May for investors, and they predict things could get stormier over the next three months.

Hedge funds lost about 2 percent to 3 percent of their value in May, according to data groups, against a backdrop of a 10 percent fall in world stocks as markets were buffeted by the May 6 "flash crash" on the Dow Jones Industrial Average, BP's Gulf of Mexico oil spill and riots in Greece against austerity measures to combat its debt crisis.

Rather than providing the all-weather returns some investors once hoped, hedge funds have developed something of a reputation for losing money in times of turbulence, albeit less than regular funds.

However, a few funds betting on fallout from rare, unforeseen events—sometimes dubbed 'Black Swans' after the book by Nassim Nicholas Taleb—reaped the benefits, as did some funds betting on currency moves or those able to hedge against market falls.

London-based 36 South Capital Management, which trades options to try and make money out of the impact of such rare events, saw big gains and said it was seeing large inflows from investors worried about volatility in coming months.

Its Gold fund, which buys out-of-the-money options on gold, returned [gains] during the month, the firm's CEO Jerry Haworth told Reuters. The strike prices on such options are some distance from market price.

36 South's Cullinan fund, which bets on inflation, gained [substantially], and its flagship Kohinoor fund [returned positive results].

Mr. Haworth admits his funds suffered during 2009's steady stock market rise and lower volatility, but doesn't see a repeat any time soon. "I think we're going into markets the likes of which we haven't seen for nine or 10 years," he said. "I've never seen so many nervous people."

Sovereign Debt Crisis

Meanwhile, bets on a deterioration in southern Europe's debt crisis helped the Matrix PVE Global Credit fund gain an estimated 15 percent in May after it returned 19 percent in April.

Gennaro Pucci, chief investment officer of PVE, said he didn't expect the debt crisis to be resolved any time soon, in spite of the $1 trillion emergency package to help stabilize the euro zone.

"The fund has had a consistent view since October about the possibility of a large tail event in the sovereign debt market, and that there would be structural problems in the aftermath of the financial crisis," he told Reuters. "We don't expect the sovereign situation in Europe to improve through the injection of liquidity into the markets, and we are preparing ourselves to take advantage of the volatility this crisis will bring."

Currency markets were also volatile. The euro dropped around 7 percent against the dollar as the debt crisis worsened, but these moves provided opportunities for some funds.

Switzerland-based Insch Capital Management, for instance, returned 4.3 percent gross of fees in its computer-driven Interbank Currency Program, while its three-times leveraged fund made 12.8 percent net of fees, its best monthly return since the height of the credit crisis in October 2008.


Other funds to gain included London-based CQS's ABS fund, which returned an estimated 2.4 percent in May, according to a source close to the company, thanks to hedges it had in place against market falls.

Purchases during the Dow's temporary slump at the start of May helped London-based Noster Capital to a 0.9 percent gain.

Meanwhile, high-frequency trading firms—computer-driven programs that can make tens of thousands of trades a day in tiny fractions of a second—may also have held up well. Many of these highly secretive firms, which some commentators blamed for the May 6 "flash crash," may have stopped trading during the slump and some made money, according to Richard Tibbetts, chief technology office at Streambase, which provides software for these ultra-fast firms.

"Most high-frequency trading firms were fine on May 6," he told Reuters. "One client was up [in performance terms] for the week.... The system ... avoids trading on suspect market data."

By Laurence Fletcher