Cash is the new black

Keith Anderson, who runs the $25.5 billion Quantum Endowment Fund for Soros Fund Management LLC, has seen enough of choppy global markets. In mid-June, Anderson told his portfolio managers to pull back on trades as the hedge fund's losses hit 6 percent for the year, according to two people familiar with the New York-based firm. As a result, the fund is about 75 percent in cash as it waits for better opportunities, said the people, who asked not to be identified because the firm is private. Soros and Moore Capital Management LLC are among hedge funds that have reduced the amount of money they're investing in stock, bond and currency markets as they look for clarity on global events ranging from the debt crisis in Europe to China's efforts to control inflation to the debate over the U.S. debt ceiling. About 18 percent of asset allocators, including hedge funds, are overweight cash, the highest level in a year and up from 6 percent in May, a Bank of America Corp. survey showed last month. Even Anderson's boss, billionaire George Soros, who made $1 billion betting against the British pound in 1992, is perplexed. “I find the current situation much more baffling and much less predictable than I did at the time of the height of the financial crisis,” Soros, 80, said in April at a conference at Bretton Woods organized by his Institute for New Economic Thinking. “The markets are inherently unstable. There is no immediate collapse, nor no immediate solution.” Louis Bacon's Moore Capital, with $15 billion in assets, cut risk as its flagship Moore Global hedge fund dropped 6 percent this year through June 30, with all the declines coming in May and June, according to investors who asked not to be named because the New York-based fund is private. Spokesmen for Soros and Moore declined to comment. Overweight Cash Funds such as Moore's and Soros's, which chase macroeconomic trends by buying stocks, bonds, currencies and commodities, have been the worst performing hedge-fund strategy this year. They fell 2.25 percent through June 30, according to Chicago-based Hedge Fund Research Inc., as managers made losing bets that the euro would fall against the dollar and that the yield on U.S. Treasuries would rise. Some managers also got caught when prices for oil and other commodities dropped in May. The biggest macroeconomic managers aren't the only ones hesitant to make large wagers. The proportion of asset allocators, including hedge funds, with lower-than-average risk across their portfolios jumped to a net 26 percent in June from a net 15 percent in May, according to the survey by Charlotte, North Carolina-based Bank of America. Tricky Markets The aversion to risk is reflected in trading volumes. Trading in the 50 companies in Goldman Sachs Group Inc.'s index of stocks most commonly owned by hedge funds fell to 4.11 billion shares in June, the lowest monthly level since August 2008, according to data compiled by Bloomberg. Part of the uncertainty stems from the fact that so much of what happens in global markets is dependent on government actions, which can distort prices and affect supplies. “Most of our funds are in an uncomfortable position in that the fundamentals are bearish, but the governments are intervening,” said Harold Yoon, chief investment officer at Hong Kong-based SAIL Advisors Ltd., which invests in hedge funds on behalf of clients. “Instead, managers have focused on tactical trading; shorting when markets are getting bullish and then covering into panic-driven selling.” Short sellers borrow stocks and sell them in hope of profiting by repurchasing the securities later at a lower price and returning them to the holder. ‘A Temporary Respite' In Europe, the debt of Ireland, Portugal and Greece has been downgraded to junk as the countries struggle to balance budgets and remain solvent. While Greece won a reprieve last month with 12 billion euros ($16.9 billion) in aid in exchange for austerity measures, European finance ministers have failed to present a solution to the debt crisis that's threatening to spread to Italy, the euro zone's third-biggest economy. “While we've had a temporary respite on Greece, the problem hasn't been eradicated and there's potential for more negative surprises as the Greek plans are implemented,” said Bruno Usai, who co-runs the $1.2 billion Pelagus Capital hedge fund at London-based Mako Investment Managers LLP. “It will take some time, possibly until the end of the year, before we see a full recovery of risk appetite” among money managers. In China, the world's third-largest economy, the government is struggling to contain inflation, curb lending and keep the real estate market from overheating. China's gross domestic product grew at a 9.5 percent annual rate in the second quarter, the slowest pace in almost two years. Consumer prices climbed 6.4 percent in June from a year ago, the most since 2008, government data released July 9 show. End in Sight In the U.S., investors are watching Republicans and Democrats battle over whether they will cut the deficit or figure out a way to raise the $14.3 trillion debt ceiling before the government's borrowing authority expires on Aug. 2. Federal Reserve Chairman Ben S. Bernanke told the House Financial Services Committee on July 13 that a failure by Congress to raise the nation's debt limit would lead to a “major crisis” and send “shock waves” through the financial system. Harry Lengsfield, co-founder of KLS Diversified Asset Management, said he's been cutting back risk since mid-May, adding that he's optimistic that things will become clearer soon. “While de-risking was the right thing to do, we're getting close to the end now,” said Lengsfield, whose New York-based hedge fund manages $900 million. “We've seen a significant widening of spreads, which throws up a number of good opportunities over the coming weeks.” ‘Big Moves Developing' This time last year, hedge funds curbed trading for some of the same reasons they're hesitant this year, mainly uncertainty over the health of Greece and other European countries and the ability of China to continue to grow while controlling inflation. It was only in late August, when the Federal Reserve said it would start buying $600 billion in U.S. Treasuries -- the second round of quantitative easing that became known as QE2 -- that funds starting taking on risk again. This year, so-called macro managers have been forced to make short-term wagers because the longer-term thematic trades haven't worked for them, Mark Enman, head of the global-trading team within hedge-fund research at Man Investments in New York, said in a telephone interview. China Question “But we could be close to something happening,” said Enman, whose firm farms out money to hedge funds. “If issues like the debt ceiling in the U.S. and European debt crisis are resolved, you could see big moves over a short period of time.” A number of events could trigger the big market moves that hedge fund managers love, traders and investors say. “It's conceivable that if Greece were to default, that would spark a rally in the markets,” said Sander Gerber, founder of Hudson Bay Capital Management LP, a $1 billion multistrategy hedge fund in New York. “Often, disasters mark the bottom.” Robert Gibbins, chief investment officer of Autonomy Capital Research LLP, a $2 billion hedge fund based in New York, said he's looking at three big questions this year, all of which he expects to be answered soon. The first is whether China can make the transition from investment-led growth to consumer-led growth. If consumer spending doesn't increase, then the country won't be able sustain its shift toward urbanization, which is part of the government's current five-year plan, Gibbons said. Infrastructure Spending A slowing Chinese economy may send commodity prices lower, which in turn would hurt the economies of emerging markets such as Brazil and Russia that produce fuel and food for China. Lower crude oil prices might also halt the European Central Bank's plan to continue raising interest rates, which would strengthen the dollar against the euro. The second question is whether the U.S. government is willing to boost its infrastructure spending at a time when Congress is struggling to cut the nation's deficit, Gibbons said. A failure to spur growth will send stocks down in the U.S. and keep the dollar weak, he said. “The private sector is deleveraging and corporations aren't deploying cash, so the government has to take up the slack,” Gibbons said. Ringfencing Europe The third issue, Gibbons said, is whether European finance ministers can agree to using joint bond issuance as a way to tackle the debt crisis in the 17-nation euro area. For Soros, while a Greek default may be inevitable, it needn't be disorderly. “While some contagion will be unavoidable -- whatever happens to Greece is likely to spread to Portugal, and Ireland's financial position, too, could become unsustainable -- the rest of the euro zone needs to be ringfenced,” Soros wrote in the Financial Times last week. --Bloomberg News--