LONDON, March 27 (Reuters) - Hedge funds are cashing in some of their chips after enjoying a bumper first quarter, wary that a sudden change in market sentiment could see them take the sort of losses suffered in last year's volatile markets.
Hedge funds returned 5 percent in the first two months of the year, the best start to a calendar year since 2000 according to Hedge Fund Research, as the European Central Bank's 1 trillion euro ($1.3 trillion) ca s h injection boosted assets across the board.
Some star names recorded huge gains. Crispin Odey's Odey European fund gained 21.1 percent and Johnny de la Hey's Tosca fund rose 13.7 percent to mid-March, while Michael Hintze's $1.4 billion CQS Directional Opportunities fund was up 13.9 percent to end-February.
Many managers remain positive on markets, but in a number of cases have opted to trim their bets, influenced by sharp volatility last year during the euro zone debt crisis that saw the average fund lose 5.3 percent and some more bullish funds take much bigger losses.
"Over the last week or so we've actually seen (risk) come off a bit," said Paul Harvey, European head of sales in prime finance at Citi.
"We all want this rally to continue but we are all relatively cautious about the broader macroeconomic environment and the political environment, and uncertainty certainly prevails."
Many managers came into this year with low levels of risk, missing out on the start of the rally after underestimating the impact on markets of the ECB's so-called Long Term Refinancing Operations, designed to avoid another credit crunch.
As markets continued to rebound during the first quarter, however, a number of funds hiked their bets, in particular favouring the commodities and financials sectors, according to one fund of funds manager.
According to Citi's Harvey, equity long-short funds upped net exposure - the difference between bets on rising stocks and falling stocks - to 73 percent, and gross exposure - the sum of long and short bets - to 165 percent this quarter.
However, in some cases this has now come down. "We've seen some reductions but (I) wouldn't say (a) huge swing to risk off," said one prime broker who spoke on condition of anonymity.
CQS's Australian founder Hintze is among those to have struck a more cautious tone recently.
In his February investor report he wrote: "We remain broadly constructive on markets but are mindful of potential volatility that could arise due to the ongoing macro uncertainty."
Managers are worried the euro zone debt crisis could flare up again, that China's economic growth is slowing, and that tensions between Iran and the West could lead to further gains in the oil price that could reignite inflation.
David Stewart, chief executive of Odey Asset Management, told Reuters the firm remained bullish on equities, preferring them to credit.
But he added: "When the market has had a good run then you often trim a bit. We haven't changed our view. We know it's going to be difficult ... Equities are the right place to be ... The LTRO has been pretty favourable to equities."
Some funds are also beginning to look at put options as a way of protecting their portfolios from market falls, encouraged by the cheaper pricing of options thanks to a fall in volatility since the autumn. The VIX, a gauge of volatility, is down by two-thirds since early October, for instance.
"Some people who haven't used it historically (are looking at using options)," said Morten Spenner, chief executive of fund of funds firm International Asset Management. "As the pricing has come down because of the VIX, it's become more attractive for people to look at it.
"People are careful having made gains," he added. "Everyone will now agree that the situation does look more positive, but there are still quite a few things to solve."
$1 = 0.7540 euros Additional reporting by Tommy Wilkes; Editing by Mark Potter