Hedge funds cut back on stocks as concerns rise that lows of a year ago might return

News - Funds

Written by Ray Clancy

Thursday, 18 March 2010 10:01

European hedge funds have been cutting back some of their bets on stocks amid concerns over the outlook for economic growth after last year’s profits bonanza, with some fearing markets could still drop below 2009 lows.

Large bets on rising stocks helped hedge funds make gains of nearly 19% last year, according to Credit Suisse/Tremont, but prime brokers say funds have grown more cautious in recent weeks in areas such as US and European stocks.

With the euro zone economy growing just 0.1% in the fourth quarter, many funds are nervous about the economic outlook, particularly after Greece’s debt crisis. Banks in particular could suffer as funding costs rise and margins are squeezed, after the financial sector was a top performer in last year’s rally.

Giving up last year’s gains would make it harder for them to earn lucrative performance fees and could persuade clients to pull out their cash.

Hedge fund manager Crispin Odey, who made huge gains from banks and other stocks after correctly calling last year’s bull market early on, recently told clients he was ‘now much less sure’ that last March’s low for the FTSE-100 index was really the bottom.

‘The problem for equities is that they depend upon profits growing and that demands that the economies are growing,’ said Odey.

According to Colin McLean, manager of SVM's Highlander hedge fund, markets could ‘quite possibly’ fall below last year’s low. ‘Rallies within bear markets can be quite large and quite sharp. The best indicator is from financials and they’re still a concern,’ he revealed.

‘Returns in emerging markets, particularly Asia and Latin America, represent an opportunity for hedge funds,’ said Mark Harrison, European head of prime finance at Citigroup.

However, some funds are worried about banks, which were one of the sectors to lead last year’s dramatic market rebound, almost tripling from trough to peak, but which have since lost around 10%.

A research report by Morgan Stanley and Oliver Wyman this week predicted as a base case a 10 to 15% drop in investment banks’ underlying revenues as one off gains pass and margins tighten. Describing 2010 as a ‘pivotal year’ for investment banks, it also forecast a base case that regulation could cost the industry around 4% of its return on equity, although this could be as much as 8%.

Financials fund manager Blue Planet said it had slashed equity exposure in its European investment trust to 20% in February from 96.7% in December, though this has crept up this month on concerns over Greece’s debt crisis.