Hedge funds change bond investors’world
By Alex Skorecki
Published: August 30 2004 20:25 | Last updated: August 30 2004 20:25
The growth of hedge funds is changing the way traditional bond investors operate. They can no longer afford to take a leisurely view of bond market prices.
A good example came in May when Marks and Spencer, the UK retailer, received a bid approach from entrepreneur Philip Green. At a stroke, M&S's most liquid bond plummeted from 95p to 81p in the pound.
“Previously, investors might have waited for more information,” says Paul Mingay, head of credit strategy at Morley Fund Management. “Hedge funds have certainly speeded up investors' time horizons.”
With more than 7,000 hedge funds now in existence, they can exert a major impact on markets.
The hedge funds often operate through derivatives, including credit derivatives, with their activities showing up in the cash bond market through the effects ofarbitrage.
In the Marks and Spencer case, the price of the cash bond was being driven by the spreads on its credit default swap. These tradable, and increasingly liquid, instruments provide a form of insurance against default. As the CDS spread widened, the bond price fell.
Adrian Grey, head of international fixed income at Insight Investment, the asset manager of HBOS, says: “Anomalies that would previously have lasted longer and been a source of profit are now taken out more quickly by the hedge funds.”
At a recent bond investor conference in London, Louise Purtle from consultancy CreditSights stressed the new challenge. “There is a dichotomy between strategic investors and hedge funds,” she said. “Exploring the impact of hedge funds and their use of derivatives is something most fund managers should be studying.”
The tensions between traditional bond investors and hedge funds revealed themselves this month in an outburst from Bill Gross, the doyen of bond investors.
Mr Gross, chief investment officer of US fund management group Pimco, in his latest monthly Investment Outlook called hedge funds a “craze” that depends largely on leverage rather than skill. Mr Gross can afford to be more outspoken than most, but many fund managers express scepticism. One point they make is that while hedge funds claimto pursue strategies thatare uncorrelated with main market trends, in practice their returns often show a high correlation.
During the second quarter of this year almost every category of hedge fund, from macro to convertible bond arbitrage, recorded losses.
Fund managers believe it is the collective effect of hedge funds adopting the same trade that has helped volatility increase. But not all see that as negative.
Dennis Gould, head of UK fixed income at Axa Investment Managers, says: “They do tend to act en masse and bring extra volatility into the market. But the extra volatility is great. It is what fund managers want.”
Gerard Lane, portfolio strategist at Morley Fund Management, says: “Hedge funds are very important for determining short-term prices. But in the longer term, which is what pension funds look at, traditional fundamental valuation is more important. The ‘noise' from hedge funds presents an opportunity for us.”
Mr Gould says a broadening of the tradable bond universe through derivatives is also welcome. For example, while there are 300 bonds in the sterling corporate market, there are now an additional 2,000 derivatives names in which to trade.
At some fund managers the approach has been “If you can't beat them, join them”. Henderson Global Investors has a team sitting alongside the traditional fixed income fund managers, although the money under management is less than 5 per cent of the total.
Daniel Beharall, its manager, says that the addition of a hedge fund gives Henderson a new string toits bow. “It's desirableto diversify the revenue base,” he says. He, too, stresses that volatility is a good thing, although he says it is “not obvious” that hedge funds create it.
Mr Gross reckons the hedge fund craze will disappear as investors realise that “they can do whatever their hedge fund manager can do at 1/100th of the price”. Others disagree. Mr Grey for one reckons the “hedge fund community is here to stay”. |
