May 31, 2011 / 3:08 AM / in 7 years

Investors flee ex-Goldman trader's Japan hedge fund

HONG KONG (Reuters) - Gaia Capital Management’s Japan-focused hedge fund, started by a former Goldman Sachs (GS.N) trader, lost more than three quarters of its roughly $150 million assets in just two months as the March 11 earthquake blew aside its assumptions, a letter to investors obtained by Reuters showed.

The GAIA J-Multi Strategy Fund, which used to be one of the larger Japan-focused hedge funds in Asia and was launched by Kenichiro Nishi, saw a 44 percent plunge in March returns as the devastating earthquake triggered panic selling in markets and forced the fund to unwind all its positions.

Its assets shrunk to $32.65 million at end-April from $92.06 million at end-March, according to the fund’s investor letter. The fund managed more than $150 million before the earthquake, five sources said.

Japan's benchmark Nikkei share index .N225 was down about 5.6 percent from March 11 till the end of April. That included a 16 percent tumble between March 14 and 15.

The fund suffered major losses in volatility-based derivatives strategies in March, the letter showed.

Following “the earthquake and the deterioration of the situation at the nuclear power plant that led to radiation leaks, both the index and volatility broke sharply out of their expected ranges on the 14th and 15th,” Gaia Capital wrote to investors in March.

“As a result, the fund incurred heavy losses that were beyond our expectations and we had to unwind all positions in the portfolio,” it said.

Nishi, who worked for Goldman Sachs between 1997 and 2003, managed about $2 billion in a Japanese convertible bond portfolio and about $3 billion for DKR Oasis before starting his Japan focused fund, according a report by AsiaHedge in 2006.

The fund declined to comment after several attempts to seek a response. A Reuters reporter visited the fund’s office in Tokyo in March but Nishi’s representatives declined to discuss the fund’s performance. E-mails to Gaia Capital bounced back.

Japan-focused hedge funds managed $15.6 billion at the end of March, data from industry tracker Eurekahedge shows.


At the heart of the fund’s strategy prior to the earthquake were the assumptions that the Japanese market would continue to drift in the short-term and remain rangebound within a narrow range and that liquidity in the derivative products it held would not vanish.

The earthquake, and the nuclear disaster that followed, shattered those assumptions while the speed at which the market reacted and the surge in volatility made it tough for the fund to adjust its positions quickly enough to limit the damage.

One trade the fund had on its books was going long certain Nikkei 225 dividend swaps -- instruments that give the holders of the contract exposure to the future dividends paid out by Nikkei 225 constituents rather than their share prices.

The fund believed markets were underestimating dividends Japanese companies will pay out in two to five years and had positioned to benefit as these expectations, and the value of the contracts the fund held, rose.

However, with companies facing escalating uncertainty as the nuclear situation unfolded, expectations of any dividends, now or in the future, collapsed.

    On the derivatives side, the fund had a put spread -- a derivatives strategy that involves buying and selling an equal number of put contracts at different strike prices -- with the maximum payout occurring if the Nikkei was around 10,000.

    Over the lifespan of the strategy, the fund expected the Nikkei to trade between the 9,500 - 11,000 range, the investor letter showed.

    The Nikkei, in fact, plunged to 8,234.6 on March 15 as headlines on the growing nuclear disaster hit trading terminals.

    Even though the fund attempted to exit positions, liquidity in the markets for the contracts it held dried up and the fund was forced to liquidate positions at the bottom of the market.

    “The situation in March highlighted several issues that we will have to address in the future, including our response to events that occur outside the financial markets (tail risk management), over-confidence in liquidity in the index futures/option market, etc,” Gaia Capital wrote to investors.

    The fund returned 36.1 percent in 2009 and 21.7 percent in 2010 with only two negative months in the two years, the investor letter showed.

    The fund gained 1.4 percent last month, bringing its loss up to end-April in 2011 to 42 percent. By comparison, the Eurekahedge Japan Hedge Fund Index was up 0.87 percent over the same period.

    The firm set up a special redemption day at the end of March and turned almost the entire portfolio into cash to meet redemptions.

    It also said in the letter that the firm would strengthen risk management and introduce stricter risk guidelines for the gamma and volatility strategy.

    Additional reporting by Nathan Layne in TOKYO and Vikram Subhedar in HONG KONG; Editing by Mike Flaherty, Jacqueline Wong and Muralikumar Anantharaman

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