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London blasts unlikely to spark fund crisis

Hedge funds which trade stock markets are likely to lose money on Thursday after a series of explosions hit London’s transport network and pushed equity prices down, hedge fund sources said.
/ Source: Reuters

Hedge funds’ losses on Thursday, after a series of explosions hit London’s transport network and pushed equity prices lower, are unlikely to be large enough to trigger a collapse, fund managers said.

Equity trading volumes on Thursday were higher than recent averages, but even if there were liquidity problems that made it difficult for managers to square or hedge positions, the chances of a blow-up are low, they said.

“Some hedge funds might find it difficult to manage risk if there are liquidity problems,” said Andrew McCaffery, chief executive officer at Attica Alternative Investments.

“But it’s unlikely that today’s events will take out a hedge fund ... Market dislocation will create opportunities as much as problems for risk management.”

British Prime Minister Tony Blair said it was reasonably clear that terrorists were behind the wave of explosions.

Long/short equity hedge funds, which buy stocks they think are cheap and sell short those they think are expensive, will probably head the list of losers, because about 30 to 40 percent of their returns come from rising equity prices.

“A couple of (long/short equity) managers might be down on the day,” said Derek Stewart, a director of Mellon Global Alternative Investments.

“But we don’t think it has any long-term implications ... It’s possible the market will be back to normal within a couple of days ... We don’t see a major problem.”

However, some equity traders who expect further falls in stock markets say a number of hedge funds may be in trouble.

“A few hedge funds managed to sell on rumors of the blasts in London, but most are still sitting on long positions, which they will have to unwind in coming weeks,” said one U.S trader based in London.

Magnitude
Major stock market indexes fell about 2 percent in Europe, while U.S. equities showed losses of less than 0.5 percent.

These moves were not big enough to cause panic, said Chris Fawcett, a partner at hedge fund firm Fauchier Partners.

“Equities are down ... but the fall is pretty small. Most hedge funds would cater for moves several times this magnitude.”

Hedge fund managers said the blasts in London should be compared with the attacks on Madrid last year, which did not destabilize the world’s financial system.

They should not be compared with the Sept. 11, 2001, attacks on New York, which did threaten financial stability, they said.

“The analogy is Madrid and not New York,” Fawcett said.

The Bank of England’s decision to keep benchmark interest rates at 4.75 percent on Thursday after its monthly meeting was taken as a sign that the authorities were not, yet, unusually worried.

Markets had priced in a UK rate cut after the attacks, thinking the bank would want to try to boost confidence.

“They have specifically not cut interest rates,” Fawcett said. “(The explosions) imply an increase in equity volatility and a number of hedge fund strategies are positioned for that.”

The Chicago Board Options Exchange’s Market Volatility Index

-- also known as the fear gauge and a benchmark measure of U.S. stock market volatility -- jumped nearly 10 percent to a peak near 14, the highest since the middle of May.

Many hedge funds that trade the volatility of equity market indexes and individual stocks will have been active in Thursday’s market, hedge fund managers said.

“Those who think things will calm down after today are probably shorting stock volatility,” one hedge fund manager said. “Volatility buyers think stocks will lurch lower.”