The Sunday Review

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Winning and losing big

PERHAPS the best-known hedge-fund play took place in late 1992 when Mr George Soros "broke" the pound by betting on it de-linking from the European Exchange Rate Mechanism.

His funds are said to have made some US$2 billion in total profits that year by wagers on sterling and other currencies -- US$960 million of which came in a single deal.

Others like Mr Julian Robertson were only just behind Mr Soros in profits from making similar bets, but it would be the face of the Hungarian emigre that would forever be linked to the speed, greed and creed of funds which combine the finest research with immense daring to make their spectacular plays on markets.

In August, Hongkong put its reputation as the world's freest economy on the line by intervening in the financial markets to stop what it saw as a cynical "double play" on its markets by international speculators.

If true, it would have been the kind of action that may have been seen as criminal activity in the United States -- if spotted by the Securities Commission.

The funds had been active before, in October last year and in February, wagering that the Hongkong dollar's peg to the US currency would pry loose because of waning competitiveness in the economy from the strong currency. The peg held and the general wisdom was that the funds had "mugged the wrong guy".

But last summer, they were back again with a new tack.

First, the hedge funds borrowed large amounts of Hongkong dollars by swapping US dollars for the Hongkong currency, using intermediaries. The purchase came from multilateral institutions which had issued Hongkong debt paper.

For this, they were willing to take an estimated interest cost of HK$4 million (S$838,000) a day for what is believed to be positions totalling HK$30 billion.

With the hedge funds holding some 80,000 short contracts, every thousand-point fall in the stock market index would mean that manipulators stood to profit by HK$4 billion.

How? Because the index fall was a near-certainty given that the usual method of protecting a currency was to make it highly prohibitive to borrow it by raising interest rates. Once interest rates go up, companies find it costly to finance their business and this inevitably leads to their share prices slipping. A slide in the index then follows.

So, anyone who has sold shares he does not own reaps a windfall. Because when it is time to settle the contracts, he is able to hand over the shares he has promised to sell by buying them from the market at cheaper prices.

It was here that the Hongkong administration moved to send the index the other way. By itself buying heavily into the top companies, it sent their share prices and the index shooting upwards. Come settlement time, the "shorters" found themselves having to pay more for the shares they had to settle than the price they had sold them at. Besides, they also had to pay the heavy interest costs of borrowing Hongkong dollars.

Instead of reaping the double play, they were now being dealt a double whammy.

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