| LONDON, Sept 3
LONDON, Sept 3 Hedge funds are split on how to
bet on German bonds, in a sign that even managers supposedly at
the cutting edge of finance are struggling to work out how paper
offering buyers a negative yield will fare as the euro zone's
debt crisis unfolds.
Germany's two-year bond yields entered negative
territory in July and currently offer minus 0.037 percent, which
means investors holding onto maturity would book an automatic
Some managers are using bonds or derivatives to bet these
sky-high prices must fall, especially if euro zone leaders try
to solve the bloc's huge debt problems by pooling debt, a move
that would shift more of the debt burden onto Germany.
Others say prices are justified by market uncertainty and by
the chance they will be repaid in valuable Deutschmarks if the
euro zone breaks up. Some also think it is worth paying Germany
simply to look after their cash because of the safety it offers.
Among managers to be shorting Bunds is Patrick Armstrong,
Chief Investment Officer at Armstrong Investment Managers, who
thinks debt sharing and inflation will push up yields. Shorting
means betting on a lower price for a security in the future.
"We still believe the Euro mess will get resolved at some
point, despite the lack of follow-through on any concrete plans
from politicians to date," he told Reuters.
"Fiscal integration and some form of debt mutualisation will
be required in any potential solution, so we expect Germany will
be on the hook for a chunk of the periphery debt in one way or
another should a positive outcome occur."
Armstrong said he went short 10-year bonds in April at
around 1.7 percent and doubled the position when rates were 1.3
percent in May. It now accounts for 7 percent of his Macro fund.
Since the crisis began, investors have shifted huge sums
into the debt of governments they see as low-risk, sending the
prices of bonds issued by the U.S., Germany and the UK soaring.
For example, the 10-year Bund yield is down from
1.84 percent at the start of the year to 1.35 percent on Monday.
"German 10-year rates are already significantly below
inflation levels, and if the market returns to equilibrium
(then) prices on 10-years generally are about 1 percent above
levels of inflation," he said. Annual German inflation rose to 2
percent in August.
The trade echoes bets that some funds have put on France,
whose bond yields are just above Germany's.
The trades come amidst a testing year for so-called macro
funds, which were made famous by the likes of George Soros and
which bet on moves in bonds, commodities, stocks and currencies.
In the first seven months of the year these funds, which
have struggled to cope with sudden market moves on the back of
comments by policymakers, gained just 1.08 percent. In contrast
the S&P 500 with dividends reinvested was up 11 percent.
A key issue when trading Germany has been whether a
worsening of Europe's debt crisis would make investors keener on
'safe haven' assets like Bunds or mean Germany will take on more
of other countries' debts, pushing up its own borrowing costs.
While bets against Bunds have attracted a number of
managers, notably U.S. billionaire John Paulson, according to a
Financial Times story in April, they have so far proved "a one
way pain trade", says ECM fund manager Sohail Malik.
And with plenty of room for investor disappointment in
September - given the expectations surrounding meetings of the
European Central Bank, which may detail bond-buying plans for
Spain and Italy, and the U.S. Federal Reserve - some funds are
getting ready to buy Bunds again for protection.
"Most macro people I speak to are looking to buy (into) the
sell-off in German bonds," said Scott Gibb, managing director
for fund of funds at Cube Capital, who says funds profited from
the fall in yields this year, before selling when yields hit 1.2
percent. "It's a dangerous game to be fighting trends."
Fund of funds managers, who invest in a basket of hedge
funds, see the trades made by a wide range of managers.
"I'd say people are more inclined to be gearing up for a
risk-off phase. There's a lot of potential for a lot of
disappointment. People are nervous."
However, other managers see a turning point in Bund yields -
the two-year is up from end-of-July lows - amidst
pressure on Chancellor Angela Merkel to give ground on European
debt sharing, and on debt-laden Spain to ask for a bailout.
"We're at inflection point. We would not be surprised about
further near term repricing of German government risk," said
ECM's Malik, a senior portfolio manager at the firm, which runs
more than $9 billion in assets.
Malik is looking at Dutch and Austrian credit default swaps
(CDS) - designed to pay out in the event of default - as a way
of betting on a rise in German bond yields, as these may move
more sharply than German CDS if its prospects deteriorate.
"Merkel's coalition is weakening and the only way I think
she'll survive the next election is through a grand coalition
with the SDP. The two parties would have to compromise on the
euro bond issue.
"The tipping point is likely to be Spain. If it has to take
a formal bailout then you'll be exposing Italy further plus
increasing rescue costs which surely means higher (German)