Third Point LLC, the $8.7 billion hedge fund run by Daniel Loeb, is profiting from dislocations in European credit markets fueled by the region’s sovereign crisis.
The firm sold protection on the riskiest slice of a derivative index tied to the debt of European companies, speculating the market in June was pricing in the likelihood of too many failures, the New York-based firm said in a July 31 client letter, a copy of which was obtained by Bloomberg News. The contract was trading at an upfront premium of 40 percent that’s declined to 20 percent, Third Point said.
The fund said it looks for “fat pitches” resulting from panicked selling, opportunities that have increased as a fiscal crisis in Greece has spread to Spain. Measures of corporate credit risk that in June soared to the highest levels in five months have subsided as European Central Bank President Mario Draghi signaled officials are prepared to do whatever is needed to preserve the euro.
“We anticipate Europe’s dysfunctional capital markets to continue generating a steady stream of similar event-driven, attractive ideas for us,” Third Point said in the letter.
Elissa Doyle, a Third Point spokeswoman, declined to comment.
Third Point sold default insurance on the first-loss portion of the so-called Series 9 of the Markit iTraxx Europe Index, built in 2008 and linked to the debt of 125 then-investment-grade companies. The contract expires in June.
The trade would start losing money after four defaults, according to the letter. The firm viewed that as “extremely unlikely” without a euro zone breakup and also bought hedges that would pay out in the event of a collapse, the firm said.
The upfront premium on the so-called equity tranche, which is exposed to the first 3 percent of losses in the index, fell to 20 percent from 40 percent. By selling it at 40 percent, they received 4 million euros in advance and 500,000 euros annually to insure 10 million euros of debt.
While Third Point gained 4.4 percent in the first half of the year, its performing credit strategy returned 4.8 percent in the last quarter and is up 16.4 percent year to date, according to the letter. Its distressed credit rose 4.3 percent in the three-month period and 15.3 percent in 2012.
Hedge funds have returned an average 1.1 percent in the first half, according to data compiled by Bloomberg.
Third Point said its most profitable investments in the second quarter included Yahoo! Inc., Progress Energy Resources Corp. and Vertex Pharmaceuticals Inc.
The hedge fund had pushed to shake up Yahoo’s board since September and flagged discrepancies in former Chief Executive Officer Scott Thompson’s resume, which resulted in Thompson’s decision in May to step down. Third Point said unprofitable investments included Delphi Corp. and teen retailer Abercrombie & Fitch Co.