Hedge Funds Wrong-Footed by Prospect of Interest-Rate Rises

The prospect of interest rate increases in the U.S. and U.K. is playing havoc with the trades of several large hedge funds.

Computer-driven funds have been trying to profit for months from steady declines in the dollar, British pound and government bond yields. But many took a battering last month when the Federal Reserve and Bank of England pointed to future interest rate rises, sending those assets into reverse.

While some funds have clawed back some ground in the early days of this month, many are nevertheless finding that this September slump has dented their 2017 performance.

The losses highlight how many hedge funds and more traditional investors have been positioned for current benign economic conditions to continue -- conditions in which inflation and interest rates stay low while bonds and stocks edge higher.

Among funds losing money is the $4.8 billion Bluetrend fund, run by Brazilian financier Leda Braga's Systematica Investments. It lost 4.7% last month, according to numbers sent to investors and reviewed by The Wall Street Journal. Despite a 1% gain in the first week of October it is down 6% for the year.

London-based Aspect Capital, which runs $6.6 billion, suffered a 4.4% loss in its Diversified fund last month, according to numbers sent to investors. Despite a 2.6% gain in early October, it is down 2.1% this year, said a person who had seen the numbers. Man Group, the world's biggest listed hedge fund firm, lost 5.7% in its $3.1 billion AHL Diversified fund. It has clawed over half of that back this month and is up 2.1% this year, according to numbers from the company.

Trillions of dollars of central bank stimulus around the world has helped push down bond yields in many cases and dampened volatility, making it a dangerous game for traders betting against this.

September "proved to be a challenging month" for quantitative funds that bet on market trends and other patterns, said Russell Barlow, head of hedge funds at Aberdeen Asset Management.

He said interest rates in the U.K., U.S. and Europe drove returns. "Funds with the larger drawdowns [losses] had more significant long rates exposure. Anyone who ended the month with a modest negative to positive performance was typically short rates," he said.

The losses are the latest setback in a tough year for many quantitative hedge funds. They've received tens of billions of inflows from investors in recent years, even as funds run by humans have suffered large outflows, as investors hunt for other ways of making money in markets driven by central bank stimulus.

However, many quant funds have recently failed to live up to expectations, with many of the market trends they like to track proving short-lived. Chicago-based data group HFR's index of quant funds that bet on market patterns is down 3% through September, with most of that loss coming last month. In contrast hedge funds overall are on average up 5.7%.

Both the dollar and the 10-year Treasury yield spiked after the election of U.S. President Donald Trump in November. But their slow and steady declines this year have provided moneymaking opportunities for these quant funds, which are programmed by Ph.D. mathematicians and the like. They funds often follow similar trading strategies, trying to latch onto market trends and patterns. Some funds have also profited from the decline in the U.K. 10-year yield.

But an unexpectedly aggressive tone from the Fed last month, when officials signaled they expect four rate increases by the end of 2018, sent the dollar and Treasury yields sharply higher.

Across the Atlantic, sterling and gilt yields jumped after the Bank of England said markets may be underestimating how soon interest rates may rise.

Société Générale SA's Trend Indicator, a model portfolio that simulates the bets these funds may place, had been positioned for falling 10-year Treasury yields and a falling dollar in September -- trades that would have delivered losses.

"The main drivers were a sharp reversal in the dollar, from a weakening trend to dollar strength, and rising global bond yields," said Doug Greenig, founder of London-based Florin Court Capital

Also losing money was Netherlands-based Transtrend, which runs $4.7 billion. It lost 6.4% last month in its Diversified Trend Program last month, according to numbers sent to investors. It is regained most of that this month but is still down 3% for the year, according to numbers from the company.

The fund's largest losses came from "typical Brexit positions," said Harold de Boer, Transtrend's head of research and development, meaning bets against the pound and bets on rising U.K. bonds. The fund also lost money in U.S. Treasurys and other bonds.

Winton Capital, one of the world's biggest quant hedge fund firms with around $30 billion in assets, lost 2.1% in its approximately $10 billion flagship fund last month. This year through the first week of October it is up 0.9%, said a person familiar with the matter.

Switzerland-based Progressive Capital Partners' Tulip Trend fund fell 17% last month, according to numbers sent to investors. So far this year through early October it is down 13.3%.

Write to Laurence Fletcher at laurence.fletcher@wsj.com

(END) Dow Jones Newswires

October 18, 2017 03:50 ET (07:50 GMT)