Lansdowne Partners Ltd. and Odey European Inc., two of the U.K.’s biggest hedge funds, started 2011 bullish on stocks. The shared view has led both firms to have one of their toughest years managing money.
Lansdowne’s U.K. Equity Fund, which oversees more than $8 billion, was down about 18.6 percent through Aug. 19 after averaging an annual gain of 15.5 percent since the fund started trading in 2001, investors said. Odey European, the hedge fund run by Crispin Odey, fell about 15 percent through Aug. 12, according to data compiled by Bloomberg. Odey, whose Odey Asset Management LLP oversees $7 billion, posted an average increase of 17.9 percent from 1992 through 2010.
The Lansdowne Equity Fund’s biggest holdings include mining company BHP Billiton Ltd., Wells Fargo & Co. and Lloyds Banking Group Plc, stocks that have fallen between 12 percent and 46 percent this year as investors lose faith that economic growth will fuel bank profits and a demand for commodities. Odey’s assessment eight months ago that he should be “very long equities” hurt him after European markets plunged this year in response to the region’s sovereign debt crisis.
“The markets aren’t trading the same way that hedge funds are trading,” said Gemma Godfrey of Credo Capital Plc, a wealth manager in London that has 1.3 billion pounds ($2.1 billion) invested in hedge funds and other asset managers. “Managers are picking companies that they believe will do well in the long term. The markets are behaving quite irrationally, reacting to macro-economic fears.”
A spokesman for Lansdowne, Europe’s biggest hedge fund focused on stocks, declined to comment. Odey, 52, is “still bullish on growth,” David Stewart, chief executive officer of Odey Asset Management LLP, said in an interview yesterday.
Hedge funds primarily in stocks were up 0.9 percent for the year through July, according to Hedge Fund Research Inc. Hedge funds broadly gained 1.7 percent through the first seven months of the year, according to the Chicago-based firm. Hedge Fund Research is still compiling data for August, a month when U.S. stocks fell the most in 14 months and European equities suffered their steepest declines since Lehman Brothers Holdings Inc.’s 2008 bankruptcy triggered a global credit freeze.
Odey told his investors on a January conference call that 2011 would be “one of those years where actually the recovery comes through,” according to a transcript obtained by Bloomberg News. “Obviously, if you think the market is going to fall apart you wouldn’t have the positions I am running,” he said.
Odey, in laying out potential risks to his view that stocks would rise, correctly predicted one factor that has ensnared markets this year: fear. He told clients eight months ago that “people remain amazingly depressed” about the global economy.
Fears that the U.S. economy may relapse into a recession and that a European country could default on its debt helped trigger a 13 percent decline in the Standard & Poor’s 500 Index during the first three weeks of August. The Stoxx Europe 600 Index plunged 22 percent over the same period.
Investor fears about banks contributed to the “harsh reaction” to Lloyds’s Aug. 4 announcement that it lost 2.31 billion pounds during the first six months of the year, Stuart Roden and Peter Davies, co-managers of Lansdowne’s U.K. Equity Fund, wrote in a letter to clients last month that was obtained by Bloomberg News. The U.K.’s biggest mortgage lender fell 10 percent that day to 34.99 pence in London trading, its lowest level since March 2009. Lloyds closed at 35.67 pence yesterday.
Combining Lloyds’s potential earnings over the next three years with existing capital and the amount of money the bank has set aside for bad loans produces a sum that equals about 20 percent of its outstanding loans, according to Roden and Davies. As a result, the money managers estimate U.K. unemployment would have to increase by about 8 percentage points for Lloyds’s capital to be eroded, an unlikely scenario that they say other investors are ignoring.
It would require “a truly staggering level of bad debts to require further capital injections,” they told clients. “The balance-sheet strength is materially underappreciated.”
Sagging confidence in Europe prompted the managers of Lansdowne’s Global Financials Fund, which has more than $2 billion, to cut their holdings in the region’s banks. The tipping point was a surge in yields on Spanish and Italian sovereign bonds, which showed that policy makers may not be able to contain the crisis, managers William de Winton, Marc Rubenstein and Stephen Kirk, told clients in an August letter.
The “net exposure” of the Global Financials fund, which invests in banks, asset managers and insurers, was cut to 8 percent in August from 18 percent at the end of July, the letter said. Net exposure measures how much a firm is hedged by subtracting bets that stocks will fall from bullish wagers.
The “only policy response which could certainly end” the contagion spreading through debt markets in Greece, Portugal, Italy, Spain and Greece would be for governments to replace sovereign bonds with “euro-zone” bonds backed by the entire European Union, de Winton, Rubenstein and Kirk wrote.
“Unfortunately, neither public pronouncements nor our own contact with policy makers suggest that fiscal union is close or even on the agenda,” they told clients. “The political outcome is obviously not susceptible to economic analysis.”
The Global Financials fund declined 13.7 percent in 2011 through Aug. 19 after posting an average annual gain of 14.4 percent since its inception in 2004, investors said.
Its managers, who have stakes in Bank of America Corp., Regions Financial Corp. and Citigroup Inc., remain bullish on U.S. banks. They predict investors will continue to shun financial stocks as long as Europe’s crisis stokes fears about the solvency of lenders holding sovereign debt.
“In times of stress, correlations rise rapidly,” de Winton, Rubenstein and Kirk, wrote in their August letter. “In the short term, U.S. banks are unlikely to escape any stresses that arise in the European banks’ space.”