China Shock Boon for This Hedge Fund That Bets on Volatility

Article in Bloomberg

Netty Idayu Ismail

September 2, 2015 — 5:53 AM BST Updated on September 2, 2015 — 8:35 AM BST E-mail

Yuan Devaluation: What it Really Means for the Region (to see video, click here)

  • Three of 36 South's strategies [rose] in August
  • 36 South sees EM, commodity currencies to remain vulnerable

36 South Capital Advisors, a London-based volatility hedge fund, profited from China’s surprise devaluation when it triggered a global market rout that spurred losses in an index of its peers.

Three of 36 South’s strategies, which bet on rising price swings, [gained] in August, based on initial estimates, Chief Investment Officer Jerry Haworth said in an interview. That would be the best monthly return in at least three years for its main fund, according to the manager. The HFRX Global Hedge Fund Index dropped 2.2 percent last month.

More than $7 trillion has been wiped from global equities since China’s shock yuan devaluation on Aug. 11 deepened concern that the world’s second-biggest economy won’t be able to shake off its malaise. Lending rates in the U.S., Europe and Japan already are close to zero and the rout is shaking confidence that the global economy will be strong enough to withstand an expected policy tightening by the Federal Reserve.

“Volatility happens when prices adjust to new realities,” Haworth said by phone from London. “The reality basically is that central banks really have not affected global GDP over the last five years. There may be some impact, but it hasn’t been enough to overwhelm the deflationary forces.”

Betting on Options

36 South prefers to buy options maturing in a year or more that it deems offer the chance for sharp gains in currency, interest rates, equities and commodity markets when they change course rapidly, the manager said.        

The fund made money last month from betting on volatility in interest rates, equity indexes and individual stocks mainly in Europe, Australia, South Korea and the U.S., he said.

The Chicago Board Options Exchange Volatility Index, which traders use to gauge levels of market turbulence, closed Tuesday just below 32, a level that before August hadn’t been seen since 2011. JPMorgan Chase & Co.’s currency volatility index rose 12.5 percent in August, the biggest surge for the month since 2007.

Emerging-market and commodity currencies-- including Australia, New Zealand and Canada’s dollars -- will continue to be vulnerable, while major peers such as the greenback, euro and yen will become increasingly volatile, Haworth said.

‘Swim With Sharks’

Investors will probably continue to take profit in Chinese stocks after the nation’s record bull market ended in June, fueling more volatility in global equities, he said.

“When you swim with sharks and somebody’s bleeding, it’s probably advisable to get out of the water,” he said. “That’s what people sort of think.”

The Fed might raise its benchmark interest rate by only 10 basis points at its policy meeting this month, Haworth said.

“My feeling is that it’s going to be such a non-event,” he said. “They will raise, but it will be so small that it will be over-discounted.”

While low and falling volatility created opportunities for 36 South to invest, it had hurt the fund’s earlier performance, the manager said.

“Between March and July, when volatility was really getting quite low, we were saying: it doesn’t get much better than this,” Haworth said. “Volatility is like a canary in a coal mine. When it’s low it’s almost telling you to buy it.”

36 South’s main fund [was down] this year through July, the firm said in an e-mail. During the European credit crisis in 2011, the fund returned [positively]. It [also gained] in May 2012.

“When a volatility regime shifts, like it seems to have done, it’s almostlike a train leaving the station,” Haworth said. “You get that first jolt and then it doesn’t seem as if anything’s happening, and then suddenly the train starts picking up speed.”