Focus on Oyster funds – Europe credit trades, and how to hedge them
Many credit managers may have lost sleep over Europe’s debt crisis recently, but for Andrew Jackson sleepless nights have come from trying to come up with non-conventional ways to protect against the crisis.
Jackson runs Bank Syz’s Oyster Credit Opportunities fund from his base at London’s Cairn Capital, and says protection against extreme events – so called ‘tail risk hedging’ – is crucial these days.
But primary problems of tail hedging now, he says, are first how to find hedges not yet also used by so many nervous rivals that they are too expensive; and second, how to find attractive instruments bearing enough yield to pay for those hedges.
“It is hard to be long anything that will pay you [to buy] the protection. If you cannot find a traditional route, you have to try to find something people have not seen yet.”
Large parts of Jackson’s working days – and possibly also sleeping hours, too, are taken up thinking laterally about these opportunities.
Plain vanilla hedging, such as volatility options on the Vix index, is expensive now, and liable to snap back as investors turn ‘risk-off’ again.
Being short Australian banks is one possibility, as Jackson explains: “People think Australian banks are a safe haven, but we think they are exposed to the commodity prices and to a massive price boom.”
They are also tied via lending to Australian property prices, and Jackson notes many of the world’s most expensive real estate markets on a pricing basis are now in Australia.
Looking at Europe again, he says it is “astonishing after two years [of the Eurozone crisis] we still do not have a clear picture of what will happen if Greece leaves the euro. This is why we have the kind of volatility levels we have.
“Markets are completely irrational and there is more fear and panic then there has ever been. Sometimes it is about fear of being short, then it is the fear of being long.”
Against this backdrop, Jackson says: “Policy makers and politicians need to do a much better job, by saying, ‘if [rates] get higher, we will do this’.”
Since Greece’s austerity supporters took power last week and the danger of a ‘Grexit’ receded if only temporarily, the necessity for Eurozone leaders to be far more clear in the near term faded.
Jackson is disappointed in their performance. He says visibility around support for Bankia remains a major issue. The Bank of Spain, for which he normally professes a higher regard, has done “a very poor job. Fitch has said another €60bn to €100bn of additional capital will be needed for the banking system, but the authorities said they do not know how much is needed. They cannot afford to say that – because that is when markets panic.
“Stability is not arrived at by saying nothing or blaming everyone – hedge funds and speculators – it is arrived at by saying ‘here is what happens now’.”
He says it is not crucial Brussels find solutions to its problems immediately, “but a willingness to discuss topics like Eurobonds would be sufficient to cause some stability,” he says.
For Jackson, it is wrong for onlookers constantly to focus on whether or not Athens will default on its debt – “the question is, ‘can you afford to hold [the debt]?’ We mark to market and it is about pricing and where you think it will go.”
While Jackson does not speak very highly of Europe’s politicians, he has praise for its chief central banker Mario Draghi, who unexpectedly offered unlimited, cheap, long-term loans to Eurozone banks earlier this year, in a program abbreviated as LTRO.
“It had a massive impact last time around, but it was also very smart for Draghi to say, ‘forget about LTRO Part 2′, because if we expect it to happen it will be priced in, but he wants markets to be nervous about short sales and to think, ‘I hope Draghi does not do LTRO 2′.”
Here, Jackson is reminded of Draghi’s US counterpart Ben Bernanke at the Fed, who is willing to flush money into the American system, to the pain of funds betting markets will fall.
Jackson says it is important central bankers reserve the power to hurt negative bets.
“With Bernanke, markets know with QE3 he can bust the markets open, and just when you think markets have gone wrong and you are positioned short, he has massive power to hurt you. The markets start to fear the tools that are available [to him].”
Jackson says the crisis has been a process of leverage moving from banks to sovereigns, to supra-sovereigns such as the IMF and ECB – but all “without dealing with the underlying problem.”
Jackson has cut leverage on the long/short Oyster Credit Opportunities fund to around 1.2 times, and has flat net exposure.
The fund comprises six strategies – long and short credit, special situations, macro hedge using index CDS, and basis- and relative-value trades. Its process is bottom-up and, luckily given the prevailing environment, also top-down.
“At the moment we are trying to avoid hidden longs in our portfolio and the focus is on doing lots of detailed fundamental analysis,” Jackson says.