Black Swan Funds Said to Soar as Europe Debt Crisis Deepens

Hedge funds created to protect investors against market shocks in the wake of the biggest recession in seven decades are soaring as Europe’s intensifying debt crisis infects markets globally.

Saba Capital Management LP’s $550 million so-called tail risk fund has gained 11.5 percent in September after increasing 15 percent last month, according to a person with knowledge of its performance. Pine River Capital Management LP’s $160 million tail fund advanced 14.5 percent in August, an investor familiar with the returns said. They asked not to be identified because the results are private.

Hedge funds have lost 4.8 percent since July 30 on growing concern that Europe’s leaders will fail to stem a crisis of confidence that has sent borrowing costs of nations from Greece to Italy to euro-era records. Saba, founded by former Deutsche Bank AG credit trader Boaz Weinstein, gained as junk bonds had their biggest monthly losses since the months after Lehman Brothers Holdings Inc.’s bankruptcy in 2008.

“The tail fund benefited from our focus on credit because equity just hasn’t moved as much proportionally,” Weinstein said. “This is not altogether surprising considering the level of fear and uncertainty related to sovereign and bank solvency.”

Weinstein declined to comment on his fund’s specific returns. Patrick Clifford, a spokesman for Minnetonka, Minnesota-based Pine River, also declined comment.

Black Swans

Tail funds derive their name from the outlying points, or tails, on bell-shaped curves that forecasters use to plot the probability of losses or gains in a given market.

Hedging against improbable events was pioneered in the 1980s by traders including Nassim Nicholas Taleb, whose 2007 book, “The Black Swan,” warned that bankers relying too much on probability models had become blind to potential catastrophes.

Taleb consults with Universa Investments LP, a hedge fund founded and owned by Mark Spitznagel that seeks to protect clients against black-swan events, a reference to the widely held belief that only white swans existed, until black ones were discovered in Australia in 1697.

Pine River formed its fund in June 2010 at the request of investors who wanted access to the techniques used by its primary multi-strategy fund, which gained 40 percent during 2008 and 2009. Saba started its version in November.

Capula, Gramercy

Other firms running the strategy include Capula Investment Management, which began a fund in March 2010 that’s grown to $2 billion. It climbed more than 5 percent this month after a 5.36 percent gain in August, according to an investor familiar with the performance. The fund has risen about 11 percent this year.

A tail risk fund managed by Gramercy, a Greenwich, Connecticut-based investment firm that oversees more than $2 billion, gained 9.8 percent in September and is up 29 percent since its May 1 inception, according to a person familiar with the fund’s returns.

The managers profited as the VIX index, a measure of stock-market volatility known as Wall Street’s “fear gauge,” more than doubled in the past two months.

A measure of price swings over a 30-day period for the Markit CDX North America Investment Grade Index, a credit-default swaps benchmark used to hedge against losses, tripled since May, reaching the highest in 14 months, prices from Markit Group Ltd. show.

The index, which rises as investor confidence deteriorates, soared to 135.9 basis points on Sept. 12, the highest level in more than two years, from 91.9 at the end of June.

Junk Bonds

Company bonds rated below BBB- by Standard & Poor’s and lower than Baa3 by Moody’s Investors Service lost 4 percent in August, the biggest loss since November 2008, according to Bank of America Merrill Lynch index data. The S&P 500 Index decreased 5.4 percent last month, including reinvested dividends, and has dropped 10.7 percent since the end of June through yesterday.

Hedge funds globally declined 4.8 percent in the seven weeks ended Sept. 12, according to a Hedge Fund Research Inc. index of preliminary data that tracks 40 firms. A broader gauge of the Chicago-based research firm fell 2.3 percent in August, the worst month since May 2010.

Billionaire investor John Paulson’s Advantage Plus Fund, which seeks to profit from corporate events such as takeovers and bankruptcies, lost 15 percent in August, two people familiar with the firm said last week. The rout extended the fund’s loss this year to 34 percent for Paulson, who has been betting on an economic recovery by the end of 2012.

BlueMountain, PAMLI

Some credit strategies that seek to avoid big bets on the direction of the economy, known as long/short funds, gained or outperformed the market last month, including New York-based Saba’s flagship $3.65 billion fund, which rose 2.5 percent, a person familiar with the fund said last week.

BlueMountain Capital Management’s Credit Alternatives Fund, which seeks to profit from dislocations between bonds, loans and derivatives, fell 1.89 percent in August, leaving its gains for the year at 3.06 percent, according to a note to investors. A spokeswoman for the firm declined to comment.

PAMLI Capital Management LLC’s $115 million PAMLI Global Credit Strategies fund gained 5.02 percent, according to a person familiar with the fund’s performance. The firm was founded in January by former Highbridge Capital Management LLC portfolio manager Faisal Syed.

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