Europe Faces Reckoning as Rescue Fails, Canada's Niagara Hedge Fund Says

Date: Friday, June 4, 2010
Author: Bloomberg

Niagara Capital Partners Ltd., operator of Canada’s two best-performing hedge funds over the last three years, is betting Europe’s almost $1 trillion debt- rescue plan will fail.

“They’ve deferred the moment of reckoning in the hope that a default can be made in an orderly fashion,” David Rothberg, chairman of the Toronto-based firm, said during an interview in his office. “It seems inconceivably naive to me to think that they’re going to get out.”

The Niagara Legacy Fund, managed by Friedberg Mercantile Group Ltd. founder Albert D. Friedberg, pared investments in an exchange-traded fund tracking Chinese equities and replaced Treasury Inflation-Protected Securities with regular Treasuries during the past six weeks out of concern the global recovery is fading. The Legacy fund and Niagara Discovery Fund, which Friedberg and Rothberg run, bought credit-default swaps on Greek, Portuguese, Spanish and Hungarian debt late last year.

European policy makers pledged loans worth as much as 750 billion euros ($912 billion) and a program of bond purchases on May 10 to halt a debt crisis that has sent the euro down 15 percent against the U.S. dollar since Dec. 31. Friedberg and Rothberg have bet against the 16-nation currency, which fell to a four-year low of $1.2111 on June 1.

Best Funds

Niagara Legacy and Niagara Discovery lead the 48 Canadian hedge funds tracked by Bloomberg with annualized returns of 26 percent and 20 percent since 2007. In the past six months, the Legacy Fund, the Canadian equivalent of Friedberg’s C$648 million ($614 million) Cayman Islands-based Global-Macro Hedge Fund, made short sales and bearish options on the Standard & Poor’s 500 index its largest investments.

The Legacy Fund outperformed its Bloomberg benchmark by 17 percentage points in Canadian dollars in the last eight months of 2009 with investments including oil, Chinese stocks and inflation-protected Treasuries.

The bearish stance at Niagara contrasts with 13 U.S. equity strategists tracked by Bloomberg News who on average forecast the S&P 500 to end the year at 1,268. That would require a 15 percent rally from yesterday’s close of 1,102.83. Bulls also include Temple Asset Management Ltd.’s Mark Mobius, who said last week he’s still buying stocks in China and called the slump in emerging markets “a correction in an ongoing bull market.”

Bearish Swaps

Credit-default swaps on Greek debt have about tripled in price between late 2009, when Rothberg and Friedberg added them to their holdings.

Rothberg said he didn’t have a chance to sell the contracts before they retreated when European leaders crafted the bailout for indebted countries. Had he exited those positions, he would have made another wager against Europe because of austerity measures demanded by the European Union and International Monetary Fund.

“They’re saying, ‘You want this money from us? You’ve got to tighten your belts,’” he said. “It means deflation if you’re going to tighten your belt. It means you’re going to be shrinking your GDP.”

Friedberg’s team became pessimistic on inflation-protected Treasuries and Chinese equities after U.S. Federal Reserve stimulus policies didn’t increase money supply. The annualized growth rate of the M2 money gauge in the U.S. declined to 1.6 percent in April from 10 percent in January 2009, according to the Fed. M2 includes currency and travelers checks held by consumers and companies for spending, as well as checking and savings accounts and money market mutual funds.

No Takers

“It was as though it was shoveling money out of a factory into a warehouse, and it was saying to the banks, ‘Come and get it. We’ll only charge you 1 percent for the money,’ and they wouldn’t take it,” Rothberg said. “They would take it, but they would only buy gold back, and they would buy Treasuries. Without money, no matter how robust the economy would grow, you would not have an asset inflation.”

The Legacy fund increased 13 percent in May, while the Discovery Fund gained 2.5 percent, Rothberg said. Hedge funds lost an average of 2.6 percent in May, the worst month since November 2008, according to the HFRX Global Hedge Fund Index. The S&P 500 retreated 8.2 percent, the biggest monthly drop since February 2007.

Now bearish on equity markets, Friedberg’s team has invested in havens, including German bonds and gold, which Rothberg says may triple in price. Futures on the precious metal traded in New York have quadrupled since the end of 2000.

“Gold is the only asset that doesn’t represent someone else’s creditworthiness,” he said. “And in a world where now the guarantors of the guarantors themselves are in peril, that’s really an issue.”