LONDON Some macro hedge funds are using the recent sell-off in the Mexican peso as an opportunity to buy into the currency.
Macro funds - which bet on stocks, bonds and currencies and which were made famous by the likes of George Soros - piled into the peso in recent months, hungry for profits after a tough two years in which they struggled to cope with markets dominated by political and central bank actions.
Until recently, the trade was one of the successes in a year that otherwise has seen macro funds down 1.09 percent, according to the HFRX index.
It returned as much as 18 percent as it went to below 12 to the U.S. dollar a month ago from more than 14 last June. But since then it has quickly lost about a quarter of those gains.
The fall is part of a wider sell-off in emerging markets, which have been hit by fears the U.S. Federal Reserve will slow its easy monetary policy sooner rather than later.
That policy has pumped money into emerging markets. In Mexico's case, the peso has also benefited from exposure to U.S. economic growth and a drop in domestic drug-related crime.
But while some hedge funds have cut both long and short exposure after the sell-off, others see a buying opportunity.
"Mexico looks pretty good, the fundamentals are solid and the new government is pursuing reforms," said Ian Gunner, fund manager at Altana Wealth. "When markets get crowded they get crowded for a reason. There's a lot of short-term noise, but out of it there will be opportunities."
Gunner has gone long the peso, taking advantage of pricing in the options market, by selling expensively-priced put options - the right to sell - on the peso against the dollar and buying call options - the right to buy.
Such a strategy would mean he profits if the peso rises strongly but loses money if it drops below a certain level.
Adelante Asset Management, which had been long the peso but took profits when it hit 12 to the dollar, has gone long the peso against the dollar and the euro in recent days.
Portfolio manager Tim Dingemans also plans to go long peso versus the Swiss franc, Australian dollar and yen because he expects the dollar to strengthen as the U.S. economy recovers.
"It does benefit from an improving U.S. economy, due to being close to the U.S. Domestic reforms are also going well."
He added: "It's now backed up a lot from (12 pesos to the dollar), which is now a much more interesting level to look to go long local currency again."
According to U.S. Commodity Futures Trading Commission data, long peso positions among leveraged funds fell by 12,470 to 114,051 over the week to May 28, while short positions fell 3,287 to 40,420 - the sixth consecutive week both have been cut.
This still leaves most positions among leveraged funds - those who borrow to buy - long.
"There's a crowded trade in the Mexican peso, which has been overlooked because everyone is focused on Japan," said one fund of hedge funds manager, speaking on condition of anonymity.
Japan has been another major macro fund trade this year based on its decision to pump money into its economy.
Not all funds, of course, are ready to jump back into the peso yet, believing it is to early in the sell off.
"In all or most emerging market currencies that are free-floating there's an unwinding of money that flowed in looking for a carry trade," said John Malloy, head of research at Miami-based Everest Capital, which runs $1.8 billion.
He said he is negative on the peso in the medium term but is bullish longer-term, citing falling crime and U.S. growth. He declined to comment on the fund's positioning.
(Editing by Jeremy Gaunt.)