Nervy hedge funds fearful of summer volatility

LONDON, July 16 Mon Jul 16, 2012 1:00pm EDT

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LONDON, July 16 (Reuters) - With politicians struggling to shore up plans to tackle Europe's debt crisis, hedge fund managers are finding it hard to come up with moneymaking ideas to suit markets focused on the latest announcement by euro zone or U.S. leaders.

Once seen as able to make money in all conditions, many hedge funds have opted to keep their bets small and their exposure to movements low as quieter summer trading looms, mindful of last August's stock market meltdown.

"Not only are we going through a period that, seasonally, is not good to take risk, but the looming U.S. elections, U.S. fiscal cliff and U.S. debt ceiling renegotiations are keeping us on the defensive," said Pedro de Noronha, managing partner at Noster Capital, whose Global Value fund rose 14.3 percent last year.

"The risk is that we may underperform a rising, illiquid summer market. But the reward for taking a lot of risk in the months ahead is just not there. We prefer focusing on capital preservation and running a tight ship until we can foresee better fundamentals."

Summer's quieter markets can be a dangerous time for investors. In the four moths to end-September last year hedge funds lost 7.9 percent on average, while equity long-short funds -- which bet on rising and falling stock prices -- lost 12.1 percent, according to Hedge Fund Research.

"I would definitely say people are still cautious," said one fund of hedge funds manager who spoke on condition of anonymity.

"It is a difficult time to do that (increase bets). I do not think anything (in the euro zone bank recapitalisation deal) is really conclusive yet."

NO SEA-CHANGE

Few funds have been convinced either by last month's agreement among euro zone leaders to allow the European Stability Mechanism (ESM) to recapitalise banks directly or by the European Central Bank cutting interest rates last week.

"What they (euro zone leaders) agreed two weeks ago needs to be formalised," said Philippe Gougenheim, chief executive and chief investment officer at Gougenheim Investments, who has recently cut his stance on equities to flat, from net long.

"In terms of capitalising banks directly, the ESM now has more to do but it has still got a similar amount of money. I do not think much has been solved."

An index of leading euro zone stocks jumped 5 percent in the session after news of last month's deal -- which saw euro zone leaders agree to bend EU aid rules to shore up banks and bring down the borrowing costs of stricken members such as Italy and Spain -- and is still up 4.2 percent.

However, many hedge fund managers look unlikely to take big bets until detail of the deal -- often a key sticking point in the euro zone's ongoing debt conundrum -- has been thrashed out.

On Monday, Germany's Constitutional Court said it would not rule for nearly two more months whether Germany can legally ratify the EU's permanent bailout scheme and the fiscal pact for budget discipline.

"There has not been a wholesale shift to become more bullish. The details (of the banks recapitalisation plan) still have not come through yet and there are still strong indicators of risk out there," said Tim Beck, senior analyst at fund of funds firm Stenham Advisors.

"People will have traded around it and may have taken profits on some of the shorts. But it does not seem to have been a trigger to change overall positioning in funds."

Not everyone was pessimistic.

"We believe there are legs in this rally," said Louis Gargour, chief investment officer at London-based hedge fund manager LNG Capital. "What has happened is not a sea-change, but ... corporates are in reasonably good shape. The problem is not corporate, it is sovereigns."

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