May 8, 2021

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Hedge funds profit from the “ big deal in reflation ”

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Hedge funds bet that US President Joe Biden’s $ 1.9 billion stimulus package will help spur a resurgence in inflation is starting to pay off, with several top managers making big gains in early 2021 .

Managers like Caxton Associates, Odey Asset Management and QMA Wadhwani are posting juicy returns as expectations of faster price increases push government bond prices down.

“Hedge funds have been warning for six months that inflation could be much hotter than expected,” said Andrew Beer, managing member of fund firm Dynamic Beta Investments, whose DBMF strategy rose 4.4% on the month last, helped by bets against 30 years. US Treasury Bills. “The month of February showed how few investors are prepared for a rapid rise in interest rates.”

Bond prices, which have seen a 40-year bull market, have collapsed in recent weeks in anticipation that huge levels of monetary and fiscal stimulus will trigger a rebound in the US economy that will force the Federal Reserve to raise interest rates sooner than expected. Supporting this has been robust in the United States retail and manufacturing data, as well as soaring commodity prices and the progress of vaccinations in the US and UK.

Long-term treasury bills, those with maturities of 10 years or more, have lost 10% since the start of 2021 on a total return basis that takes into account price declines and payments of interest, according to a Bloomberg Barclays Index.

Meanwhile, the five-year break-even rate, a measure of market-based inflation expectations, rose above 2.5% on Wednesday for the first time since 2008, according to Bloomberg data.

“The scene may well be set for a big reflation,” Caxton chief executive Andrew Law wrote in a December letter to investors seen by the Financial Times. He added that it would “probably be a dominant investment theme”.

Line graph of the five-year break-even rate (%) showing that medium-term inflation expectations in the United States have reached their highest level in 13 years

The bet paid off: Caxton, which posted its best returns last year, gained 7.2% in its Macro fund, managed by Law, and 4.5% in its main fund this year, according to an investor. .

Meanwhile, Odey’s European fund, managed by founder Crispin Odey, gained 38.4% last month, according to investor documentation seen by the FT, bringing gains this year to 51.1%. The fund made large bets on UK and Japanese government bonds. The company recently wrote to customers to tell them it is forecasting US inflation of 10 to 15 percent this year. This far exceeds estimates by economists in a Bloomberg poll, who on average expect consumer prices to rise 2.3% this year.

Brevan Howard, the company co-founded by billionaire Alan Howard and run by Aron Landy, gained about 3.4% this year in mid-February. The firm has been positioned for higher yields, said a person familiar with its positioning. Brevan, Caxton and Odey declined to comment.

Hedge funds such as Caxton and Brevan Howard made big gains last year betting on falling bond yields as central banks cut interest rates and investors fled to havens.

Those funds have now reversed their bets, say people familiar with their positioning, with growing concerns among major fund managers that bonds have reached unsustainable levels.

Low bond yields are “an accident waiting to happen,” wrote Paul Singer’s Elliott Management in a recent letter to investors seen by the FT. Warren Buffett warned Last week that “ties are not the place to be these days”.

Line graph of 10-year yield (%) showing US Treasuries in a long-term bull market

Some funds kept the trade going through so-called “steepening the yield curve” positions – betting that the spread between two-year and ten-year US yields will widen. Higher yields indicate lower prices. Steepener trades have proven to be profitable this year, as this gap hit its highest level in over four years last month.

Other managers took advantage of bets on stocks that are likely to do well in the face of rising inflation. James Hanbury of Odey earned more than 20% of his Brook Absolute Return funds last month, according to figures sent to investors. He wrote in January that he had positioned himself for higher inflation amid progress on the vaccine and supply shortages in many industries, according to a letter to investors.

Computer funds have also benefited from both the bond selloff and commodity prices, which have soared as investors sought hedges against inflation.

QMA’s Sushil Wadhwani, a former member of the Bank of England’s Monetary Policy Committee, told the FT that he expected a “material” rise in global inflation this year, driven by rising prices. commodity prices, fiscal stimulus and pent-up demand in the economy.

“The rise in bond yields in February represented them ‘catching up’ with movements in stocks and commodities, he said. His fund gained around 8.5% last month, helped by betting on bonds , “steeper” transactions and positions in commodities.

London-based GSA Capital Partners, whose Trend fund gained 5.3% last month, also took its gains to around 4.2% this year, helped by bets on rising commodities and falling prices. bonds, said one person who had seen the numbers.

With the rebound in bonds in recent days, some managers, like Wadhwani, warn that prices may have moved “too far, too fast”. However, others believe the Fed’s tolerance for higher inflation means bond prices may fall further. Kamran Moghadam, who heads the global macro team at Partners Capital, said he was reducing bond holdings due to “increased inflation risks.”

“He’s come a long way very quickly,” said the head of a large hedge fund. “But the trade is still going on.”

laurence.fletcher@ft.com



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