For some Asian hedge funds, market rout is sweet

HONG KONG Tue Aug 9, 2011 6:05am EDT

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HONG KONG (Reuters) - Asian hedge funds Vulpes, started by industry veteran Stephen Diggle, and Tantallon Capital are emerging as winners in a volatile August that has wiped more than $3.8 trillion off global stock markets.

Diggle, who made a fortune during the financial crisis, told Reuters his long Asian volatility and arbitrage hedge fund LAVA gained about 4 percent in the first six trading days of the month.

The fund's bets on volatility going up paid off as the U.S. government struggled to piece together a deal to address its fiscal problems and S&P cut its AAA rating.

Tantallon Capital, founded in 2003 by former Morgan Stanley (MS.N) wealth management executive Alex Hill and Nicholas Harbinson, who earlier worked at Merrill Lynch and Goldman Sachs (GS.N), gained 4.15 percent in its flagship fund last week, according to a letter to investors seen by Reuters.

On the other hand, some of the biggest Asia ex-Japan-focused stock mutual funds from firms such as Fidelity, JP Morgan Investment Management and Franklin Templeton lost more than 10 percent this month versus the 7.3 percent average loss for peers, according to data from Thomson Reuters Lipper.

By comparison, Asian shares as measured by the MSCI index of Asia-Pacific stocks outside Japan .MIAPJ0000PUS plunged 8.7 percent last week and extended losses to 11.8 percent on Monday.

"Everyone is just trying to reduce their exposure to equities principally in a very thin August market and that has caused very significant volatility," Diggle said.

"We are basically long risk and that's going higher," said Diggle, who made $2.7 billion (1.65 billion pounds) for investors between 2002 and 2009, mostly during the financial crisis at his previous hedge fund firm Artradis.

Singapore-based Artradis shut earlier this year after double-digit losses in its main funds in the prior two years.

Vulpes and similar hedge funds bet on volatility using options. In times of low volatility, such as the second quarter of this year, the premium required to buy out-of-the-money options falls, rendering them cheaper to buy.

Funds looking to hedge portfolios against rare but highly risky 'Black Swan' events or funds betting markets are underpricing volatility could take advantage of low prices to load up on such options. And as volatility shot up last week, such bets paid off.

The VIX .VIX, a 30-day risk forecast of stock market volatility and a key measure of investor anxiety, has been rising and soared to 48.0 on Monday, its highest close since March 2009 and posted its biggest daily percentage gain of 50 percent since February 27, 2007.

Vulpes manages $185 million in assets. Tantallon manages more than $300 million.

The Macquarie Asian Alpha Fund, a $1.5 billion market-neutral long/short Asia-focused hedge fund from Macquarie Group (MQG.AX), was up 0.4 percent last week, according to a person with direct knowledge of the matter.

Hedge funds in Asia are widely expected to suffer in the stock market selloff as many tend to be long biased. During 2008, they lost about 27 percent, according to the Eurekahedge Asia ex-Japan Index.

While high frequency traders are also performing well, some hedge funds are down as much as 8 percent this month, according to a prime broker, who did not want to be identified

BONDS ARE WRONG BET

Diggle said although Asian equities had been "punched in the head really hard", investors believed the storm would pass because while short-term volatility jumped over the last six sessions, longer dated volatility was up very little.

"Where we think markets are getting it wrong is that the immediate reaction that people have to low growth numbers, you sell equities and you buy bonds ... buying bonds now is completely the wrong thing to do," he said.

"Clearly any country that owes $14.3 trillion and in three years time will owe $17 trillion is not a safe haven," the former Lehman Brothers executive said.

"If you ask me do I think that the U.S. government deserves AAA rated status for its debt, I would say no and not for a very long time."

He said his firm would rather bet on increased weakness and volatility in government bond markets than on equities which looked okay at current levels.

Diggle is expecting most Western governments to lose their AAA status and investors to question the solvency of government bond markets.

"Where we see future instability is increasingly in Western government and Japanese government bonds because I don't think they are a safe haven. They are a false safe haven."

"I don't think that lending money to governments, if they look like becoming insolvent governments, is a great idea, full stop."

MUTUAL FUNDS

With no options to hedge the downside, sliding markets have hammered the net asset values of mutual funds.

Asia-Pacific ex-Japan-focused funds managing more than $1 billion in assets lost an average 10 percent in the first six trading days of August, according to data from Thomson Reuters Lipper.

Mark Mobius' $18.5 billion Templeton Asian Growth fund lost about 11.9 percent of its net asset value, or about $2.2 billion.

Big losers also included the $1.4 billion JPMorgan Asia Equity Fund (-13.6 percent) and the $1.86 billion Fidelity Emerging Asia Fund (-13.5 percent).

(Editing by Muralikumar Anantharaman and Dean Yates)

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