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Kynikos Alumni Start Hedge Fund Betting on Declining Stocks

Two former analysts of Jim Chanos’s Kynikos Associates Ltd., which rose to fame shorting Enron Corp., started a new London-based hedge fund earlier this month to bet on falling stocks globally.

The Arhammar Short Alpha Fund Ltd., which started on Oct. 10 and is backed by the second-largest Baltic bank SEB AB, will invest in 30 to 50 stocks which are expected to underperform the market, co-managers Mike Monnelly and David Bonnier said, declining to specify the amount of capital the fund has raised.

Arhammar is seeking to meet demand from family offices and funds of funds for assets with a different return profile than traditional stocks, property and fixed-income securities to help preserve capital and protect their other investments, Bonnier said in a telephone interview from London on Oct. 29.

“Today there’s a lot of frustration that there are not many places to invest your money because either equity is expensive, or real estate is expensive, or fixed income is expensive,” he said. “The number of dedicated short-biased funds has diminished considerably in the last 10 to 15 years.”

Shorting involves selling borrowed shares and making a profit buying them back when prices decline.

Enron Bet

Monnelly and Bonnier worked as London-based analysts for Kynikos providing research and generating ideas for stock shorts for the New York-based company that now oversees about $6 billion of assets.

Kynikos bet on the decline of Enron shares before the energy trader filed for bankruptcy in 2001. It has placed similar wagers on Chinese banks and Brazil’s Vale SA, the world’s largest iron-ore producer, on an expected slowdown of China’s credit-driven growth, according to founder Chanos.

Monnelly, 39, went on to help oversee short stock investments at GMO LLC, the Boston-based manager of $108 billion assets, between 2009 and early May this year, he said. He focused on markets influenced by China as a hedge against a hard landing in the world’s second-largest economy.

Bonnier, 36, left Kynikos in November after about six years.

The Eurekahedge Hedge Fund Index returned 4.3 percent through September, trailing the MSCI World Index’s 15 percent in the period. The hedge-fund gauge has outperformed the MSCI World Index in 2011 and 2008, when markets wobbled amid the European debt crisis and the global financial crisis.

Excessive Credit

Arhammar will restrict its shorts to stocks listed in developed markets in North America and Europe as well as Japan, Hong Kong, Australia and Singapore, said Monnelly. The fund buys a basket of stocks, for example, the MSCI World Index, to protect against market risks, Monnelly added.

It will pick stocks to short using bottom-up analysis that focuses on individual companies along four themes at all time: boom-that-goes-bust, consumer fads, aggressive accounting and structurally challenged businesses, Bonnier said.

Examples of the boom-that-goes-bust theme include companies related to the subprime crisis of 2008 and the current China construction bubble, said Bonnier.

“One common feature that underlies the boom-that-goes-bust theme is excessive credit growth,” said Monnelly. “Excessive credit growth and new forms of financial intermediation is one reason why we have concerns about the Chinese credit system and the associated high level of construction.”

China’s biggest banks tripled the amount of bad loans written off in the first half, cleaning up their books before what could be a fresh wave of defaults, according to filings.

Consumer Fads

The consumer fads theme targets “consumer-friendly” companies that have generated little or no profits and are in a late stage of stock rallies, Bonnier said. An example is Green Mountain Coffee Roasters Inc., which has drawn short bets from David Einhorn’s Greenlight Capital Inc. and Whitney Tilson’s Kase Capital on accounting practices and increasing competition.

Newspapers and traditional music labels fall into the category of structurally challenged businesses, or companies with obsolescent technologies, said Bonnier. With less volatile share prices, their inclusion in the fund would help reduce the overall fluctuation of its performance, Monnelly said.

In aggressive accounting, Arhammar looks for companies that try to manipulate underlying earnings, for example, through practices such as questionable use of mark-to-market accounting, they said.

The two named their hedge fund after Bonnier’s Swedish holiday rendezvous.

“It’s really very much off the beaten path,” Bonnier said. “And that’s very much in line with our strategy.”

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