Are white-knuckle traders a dying breed in macro funds?

Just a few years ago, Glen Point Capital co-founder Neil Phillips was celebrated as an aggressive but canny trader in the mold of one of his macro hedge fund’s main investors, George Soros.

As of last week, Phillips is a convicted felon.

Phillips, 53, was found guilty of commodities fraud on Oct. 25 after only a few hours of deliberation by a federal jury in New York that decided his $725 million in foreign-exchange trades on Dec. 26, 2017, constituted market manipulation. The verdict will likely serve as a caution to other traders making outsized bets in narrow markets.

But such traders are already increasingly scarce, with many macro funds, which bet on economic trends across a wide range of assets, relying more on algorithms and quantitative strategies than white-knuckle bets. Perhaps nowhere has that shift been more pronounced than in foreign exchange, the area in which Soros first rose to widespread fame with his 1992 bet against the British pound.

The FX market today is increasingly dominated by quant-driven, programmatic flows. To be sure, currency funds have still been able to deliver solid returns for investors. But as Bloomberg reported last year, the number of FX-specific funds has declined by nearly 80% since peaking in 2010, according to data provider BarclayHedge.

Phillips’s lawyers have already said they will challenge the verdict. “We continue to believe very strongly in Neil’s innocence,” defense lawyer Sean Hecker said last week. Phillips is scheduled to be sentenced on March 14. He faces a maximum of 10 years in prison, but is unlikely to get such a lengthy term.

TRADER TESTIMONY

The weeklong trial offered a unique window into the inner workings of a trader-driven macro fund which focused on 25 emerging markets and at one point managed more than $2 billion for clients like Soros and the Teacher Retirement System of Texas. Glen Point ultimately closed last year after a failed merger with rival macro fund Eisler Capital.

Phillips was convicted of manipulating the market to trigger a $20 million option tied to a “barrier” dollar-rand exchange rate. A former Glen Point trader testified during the trial that a bet of that size was hardly unusual for Phillips.

“There were days that you saw him make tens of millions of dollars for the fund, for his investors, yes?” Hecker asked the trader, David Coratti, during the trial.

“On a few occasions, even a hundred million,” Coratti answered.

“And the reverse is true, correct?” Hecker pressed.

“Yes,” said Coratti, who now works at Moore Capital Management.

INVESTMENT 'THEMES'

Former Glen Point analyst Nick Croix described for the jury how the macro fund tried to identify “themes” around broader economic and political trends.

“We would identify what we thought would occur with that theme,” testified Croix, who now works at Balyasny Asset Management. “We would identify an asset that would be related to it. And we would pick the timing and the size to implement that trade. And we would either trade until the market trended in that general direction or we would hold it into the event itself.”

But Croix also testified that Glen Point engaged in day trading on a much shorter horizon and recalled that Phillips was “quite active” in those trades.

“I sat next to him,” Croix said, “and I observed the trading.”

One Bloomberg chat from December 2017 showed Phillips instructing his execution team to buy $50 million worth of Swiss francs, sell 300 million Australian dollars, and sell 500 gold futures contracts — all in the span of roughly 15 minutes.

'GET IT THRU'

At trial, Phillips’s lawyer sought to depict his burst of Dec. 26, 2017, rand-buying as tied to a long-term thesis that the currency would rise once Cyril Ramaphosa emerged as the next president of South Africa. Croix and Coratti both testified that this was a theme often discussed at Glen Point. A native of South Africa, Phillips had strong feelings about Ramaphosa’s predecessor, Jacob Zuma, whom he regarded as corrupt, Croix said.

“He hated him,” the analyst said.

But the jury was apparently swayed by the heavy concentration of trading days before the option was set to expire, as well as Dec. 26, 2017, chat messages in which Phillips said he wanted “to break 50,” an apparent reference to the barrier rate of 12.50 rand against the dollar, and “get it thru.”

Phillips’s lawyers had highlighted the fact that Phillips’s counterparty on the option and alleged fraud victim was Morgan Stanley. The defense contended that the bank wasn’t hurt by his actions and, in fact, was playing the same game itself. Morgan Stanley sold more than $560 million in rand on Dec. 26, 2017, much of which was bought by Phillips.

Big banks are no strangers themselves to accusations of misconduct in the currency markets. In 2015, JPMorgan Chase & Co., Citigroup Inc., Barclays Plc and the Royal Bank of Scotland Plc pleaded guilty to charges that they manipulated exchange rates and agreed to pay $2.5 billion in criminal penalties. Banks around the world have paid more than $10 billion in penalties for misconduct in the currency markets since regulators began cracking down more than a decade ago.

Until the Phillips case though, prosecutors hadn’t really brought an FX fraud over such a specific set of trades. The outcome suggests that may now change.

“Every one of these cases is new ground, trying something out that the prosecutor thinks is winnable, but the jury is the ultimate test,” said Andrew Verstein, a law professor at University of California, Los Angeles. 

Regulatory and law enforcement scrutiny is another reason that hedge funds have ceded ground in the FX market to big multinationals. Corporate treasuries hedge their balance sheet with currency trades at regular intervals, generating lucrative, steady fees for the banks. 

Earlier this month, Bloomberg reported that Apple Inc. alone counts roughly $135 billion in FX derivatives on its balance sheet. By comparison, currency-focused hedge funds control a combined $78 billion.