By Svea Herbst-Bayliss and Katya Wachtel
BOSTON/NEW YORK, Oct 16 (Reuters) - Hanging tough seems tohave been the right strategy for a good number of money managersnow that Congress has approved a stop-gap deal to avoid afederal debt default and reopen the U.S. government.
Hedge fund manager David Tawil said that, after livingthrough the collapse of Lehman Brothers, many on Wall Street arenow well-versed in telling a real financial crisis from one thatis more of the smoke and mirrors variety and much more easilyfixed.
The manager of the $60 million Maglan Capital, which tradesmainly stocks, did not do anything particularly different withhis portfolio during the three weeks Republicans and Democratsbattled over a plan to reopen the federal government, and comeup with an agreement for lifting the nation's debt ceiling.
"Those of us who invest on the basis of assigningprobabilities to various outcomes, essentially gave this one azero," said Tawil of the prospect of Congress not raising thecountry's borrowing ability and letting the federal governmentdefault on its debt obligations.
Tawil and other hedge fund managers spoke to Reuters aheadof Congress voting on the fiscal deal.
Tawil's hang tough strategy made a lot of sense with hisfund up 34 percent this year, compared with a 5.6 percent gainfor the average hedge fund.
Other money managers also said the political theatrics ofthe past few weeks were more of a nuisance than a real threat.
Some of that is because managers have already been through aseries of politically provoked fiscal crises beginning with the2011 debate to raise the debt limit, the battle to raise taxeson the wealthy and the more recent fight over sequestration andautomatic budget cuts. In all of these situations, Wall Streetsaw a potential crisis averted by a last-minute deal hammeredout by the political parties.
Others, meanwhile, said there were simply few opportunitiesto make money off the drama so it simply made more sense not tomake big changes to their investment strategies.
Sander Gerber, chief investment officer for Hudson BayCapital Management, a $1.6 billion hedge fund firm, said therehad been worry, but not panic, about a possible default. He saidthere was more concern about a debt default in 2011.
During the current fiscal crisis, Gerber said his firm,which invests in stocks, bonds, convertible debt and mergerarbitrage strategies, did not dramatically change its positionsapart from adding some extra hedges to protect in the event of adefault.
"The majority of the fund world thought it was utterlyinconceivable that the U.S would default on their debt," Gerbersaid.
He said more damage was done to portfolios, in particularinvestments in bonds, by this summer's spike in Treasury yieldsprompted by fears the Federal Reserve would bring a quick end toits $85 billion in monthly bond purchases.
The Fed's bond purchases have helped stock prices all yearby forcing investors into riskier assets. Even with a stopgap measure in place, talk about the Fed tapering those bond buysmight be put on hold.
On Tuesday, Richard Fisher, the hawkish president of theFederal Reserve Bank of Dallas, told Reuters the fiscal standoffmeans even he would find it difficult to make a case for scalingback bond purchases at the Fed's policy meeting on Oct. 29-30.
"My personal opinion is that it's not in play," Fisher said."This is just too tender a moment."
And some on Wall Street are thinking tapering may get pushedeven further out into next year.
Jason Ader, whose Ader Investment Management allocates moneyto a number of small hedge funds, said most of the moneymanagers trying to gain a tactical advantage in the fiscalcrisis were short-term traders. He said an indication that mostmanagers were not particularly worried about a governmentdefault is that so-called crash protection on Standard & Poor'sfuture contracts was still priced relatively low as ofWednesday.
Even as the hand wringing continued in Washington, WallStreet kept moving ahead, with the Standard & Poor's 500 gaining3.6 percent in the last five days driven largely by the ups anddowns in Washington with little regard to corporate earnings. OnWednesday alone, with a deal almost done, the S&P 500 rose 1.38percent and the Dow Jones Industrials was up 205 points, or 1.36percent.
Wall Street's fear factor, as measured by the CBOEVolatility Index, also remained in check, hovering around 15 onWednesday, the middle of the typical 10 to 20 range when marketsare calm.
But even as markets looked relatively placid, some fundmanagers took pains to describe to investors that they were notjust doing nothing.
So while there was not a dramatic exit from stocks, somemanagers who did not want to be identified said they noticedsome rotation into more defensive stocks. This helped names suchas Johnson & Johnson rise nearly 4 percent and Procter &Gamble Co go up 2.68 percent in the last five days.
Jack Flaherty, an investment Director in the Fixed IncomeInvestment team at GAM, which manages $123 billion, saidmanagers who were trying to prepare for the worst were mainly buying put options on the S&P500, betting the index woulddecline at some point. If a deal does happen, investors wouldlikely lose money on those put options, but probably not much.
"The actual outlay is not that much," Flaherty said. "A lotof the 'shorts' in the market are of that nature, so it's notgoing to hurt anyone horribly when a deal is finallyconsummated."
One hedge fund strategy that might profit from marketanxiety about a debt default, especially if a deal does fallapart at the last minute, are so-called volatility funds, whichuse complex trades to take advantage of pricing discrepanciescaused by gyrations in global financial markets.
These funds earn big returns when volatility is high andbleed money when markets are calm.
But so far, volatility funds have not done well this year,not even in the weeks leading up to the debt ceiling deadline.To date, an index by brokerage Newedge that tracks 10 volatilityfunds is down about 2.5 percent for the year.
And on Wednesday, with a deal almost at hand, volatilityfunds may have been hit particularly hard with the CBOEVolatility Index, or VIX, falling 21 percent, the biggest dailydrop since August 2011.
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