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View the article online at http://citywire.co.uk/wealth-manager/article/a639115

Tail-risk free QE rate trades

by David Campbell on Dec 05, 2012 at 00:01

Tail-risk free QE rate trades   A surge of central bank liquidity has warped global yield curves and created a host of rate arbitrage opportunities across the world, according to GAM Star Global Rates manager Adrian Owens.

A relative curve flattening trade in European versus Canadian two-year to five-year rates was the biggest contributor to returns in October, with a similar position in Japan also coming good over the month.

‘If you think interest rates in the US are unsustainable [long term], you can buy a put on a three-year swap with a three-year maturity, giving an effective duration of six years,’ said Owens.

‘You can get the same in Europe for zero cost. If interest rates fall, it doesn’t lose you any money and it doesn’t cost. If yields rise, you will make money, as long as the US rises more than Europe. It is one of the few bearish interest rate trades with little tail risk, and there is no carry.

Bernanke crushes short end of curve

‘Why can you do that? Well, [Federal Reserve chairman] Ben Bernanke has said he will not lift rates until after 2015, so volatility has been crushed at the short end [of the curve] but that will at some point appear at the long end.’

The manager has had a strong 12 months, returning 12.6% versus a peer group average of -0.9% across the 17 funds in the Citywire Alternative Ucits Global Macro sector.

That followed a more difficult 2011, though, in which the fund lost a total of 7.16%, with a maximum drawdown over the period of 11.06%.

‘We were long the fundamentals [at the start of 2011] and placed for recovery, and went short some of the commodity currencies. The core currencies did better than we expected, and the commodity currencies did better than we expected,’ said Owens.

‘The euro did not do as badly as we had expected because over that period of stress, the banking sector was repatriating money, which supported the currency. But once those flows came to an end we recouped those losses quite quickly.’

The manager has also recently dropped his sterling short, on what he described as ‘a little better’ lead indicators pushing back the likelihood of an imminent announcement of further quantitative easing.

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