European Woes Pave Way for Cash

Terry Flanagan

Hedge funds prepare for volatility stirred by the Eurozone debt crisis; harping that “cash is king.”

Oklahoma City-based, Covenant Investors preaches that “cash is king” in light of volatility brought upon the European debt crisis.

“It’s important to be raising cash to purchase assets at discounted prices when significant downside volatility arises,” said Chief Investment Officer Steve Shafer, of Covenant Investors.

“We think volatility itself is an asset class to be traded… but while most people want to be long volatility, we think there’s more value in selling volatility at high prices,” he said, noting the firm strategizes to “then buy back when volatility cools off, thereby pocketing the differential in premium.”

Moreover, Shafer preaches raising cash in “advance of the downdrafts that will result from macro/secular forces bringing themselves to bear on markets in the coming months.”

Prime examples include the recent Eurozone sovereign credit crisis, and more generally, developed market economic weakness.

Naturally, hedge funds employing short selling strategies may benefit from broad market declines. For Shafer, short selling is most attractive in credit strategies. “Seeing some pockets of short term distressed selling may offer compelling opportunity across the credit universe,” he noted. But, short selling is opportunistic as it applies to a fund’s investing time horizon and “scope of recognition”—or comfort level.

Losing strategies throughout Europe’s woes include “those too focused on the short term and/or cyclical nature of the economy, and not focused enough on the unintended consequences of secular impacts like government intervention (or the lack thereof) emanating out of Europe right now… just as it did out of Washington for the U.S., in July and August (referring to the debt ceiling raise debate in Congress),” said Shafer.

The inclusion of government’s role in strategy plays are a natural fit for the global macro themed hedge fund. The firm’s current assets under management are estimated at 300 million, according to Bloomberg.

Based on August 2011 data on hedge fund performance, “what works right now is capital protection, not being afraid of reduced exposure and having the ability and mandate to be very flexible in what you invest,” Shafer told Markets Media.

“Funds that are locked in to a specific strategy or asset class will be the ones with the least amount of ‘wiggle room’ in this environment (of high volatility spurred by the Eurozone debt crisis).”

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