LONDON Feb 22 Hedge fund managers who profited
from a huge rally in credit since last summer are seeking ways
to protect themselves against a sharp market sell-off if
investor confidence evaporates.
Managers have been selling some bonds, increasing short
positions or moving away from areas of the market more sensitive
to a swing in sentiment, following a 38 percent drop since June
in the iTraxx index, which measures the credit risk
premium for a basket of high quality European bonds.
Many investors and managers of more traditional funds remain
positive on the outlook for credit this year, after the European
Bank pledged to do "whatever it takes" to support indebted euro
That promise persuaded investors to pile into riskier assets
but some hedge funds fear the rally has hidden stubborn problems
like bad bank loans and the capacity of countries like Italy,
which goes to the polls this weekend, to complete painful
"The market is so positive. Meanwhile, things are happening.
There has been a lot of negative news from companies, problems
are starting to come out," said Gennaro Pucci, founder of hedge
fund firm PVE Capital.
"We want to see how the Italian election progresses. If
Berlusconi comes back to power it will be a big disaster for the
His fund profited from long positions in the first half of
January, but he has since sold bonds, bought 'out-of-the-money'
options to protect against market falls and put on short
positions on bonds in peripheral countries such as Italy.
Out-of-the-money options are those where the price at which
the owner can exercise that right are below the current market
Pucci's shorts - bets on a lower price - include bets on
tier one Italian bank bonds, as he believes there is not enough
clarity on losses at ailing Banca Monte dei Paschi.
"We believe the losses from Monte dei Paschi can spread. If
non-performing loans are rising in one bank, they could be seen
spreading. We're looking at contagion risk, primarily in Italy,"
While hedge funds have enjoyed the credit rally - funds
betting on fixed income corporates gained nearly 10 percent
between June and January - some worry about a sharp sell-off if
investor sentiment - so bullish in recent months - turns sour.
Muzinich & Co hedge fund manager Jason Horowitz told Reuters
he expects volatility to increase this year as money moves in
and out of credit and said he has been buying "cheap protection"
by shorting bonds of highly levered cyclical companies that have
already rallied strongly.
And Sal Naro, founder of U.S.-based Coherence Capital and
former co-managing partner at $4.8 billion fund firm Sailfish
Capital, said he "significantly changed" his positions in
January. He sold bonds and added short bets in the financial
services and publishing sectors and Middle Eastern sovereigns,
although he noted that spreads have widened in recent weeks.
Even hedge funds which still see bargains in Europe are
sounding a cautious note.
Louis Gargour, CIO of hedge fund firm LNG Capital, said
credit markets were "frothy, (but) not fundamentally flawed",
adding some European corporate bonds are still "super-cheap".
However, he has been moving from high-yield bonds to bonds
he think will be less influenced by investor mood, favouring the
bonds of Spanish regions such as Madrid and Catalonia.
"Risk appetite will move high-yield," said Gargour.
"Stressed companies and idiosyncratic stories are not influenced
by the greater market but by the individual situations. More
nimble investors should (stay) away from something that can be
affected by general risk appetite."