(Bloomberg News) Hedge funds that trade bonds and loans are increasing bets that Europe's sovereign debt crisis will spread to Portugal, Spain and Italy, even after Greece won a temporary reprieve with 12 billion euros in aid.
"Nothing you've seen so far has dealt with solvency, just liquidity," said Simon Finch, head of credit trading at CQS UK LLP, a London-based hedge fund that oversees $11 billion.
Finch, who has bought and sold corporate bonds and loans for 18 years, has stepped up trading in mobile-phone, utility and toll-road companies in the three countries. He expects their governments will be forced to slash spending to pay off lenders, slowing growth and reducing discretionary consumer outlays.
CQS is among the hedge funds that say investors are underestimating the odds of distress or even default not only by Portugal, whose credit rating was downgraded this week to junk status by Moody's, but also by the bigger Italy and Spain. The funds are moving beyond a direct wager that sovereign debt values will tumble, targeting potential fallout in the corporate-debt market and the banking industry.
"We are on the verge of an economic collapse which starts, let's say, in Greece, but it could easily spread," billionaire investor George Soros said during a panel discussion in Vienna on June 26. "The financial system remains extremely vulnerable."
Laying Low
Most hedge funds had been hesitant to make big wagers against European debt ahead of the parliamentary vote in Athens last week that led to the European Union approving the aid to Greece, said Omar Kodmani, senior executive officer at London- based Permal Investment Management, a unit of Legg Mason Inc. that has invested $23 billion with hedge funds on behalf of clients.
Finance chiefs of the 17 nations that use the euro also pledged to complete work on a second rescue package that could reach 85 billion euros ($122 billion) and would involve banks rolling over 70 percent of Greek bonds maturing by mid-2014.
"Most opinions on the euro-zone and Greece were not very pessimistic," Kodmani said. "People saw it as a problem that could be postponed, so there hasn't been much negative positioning."
Hedge funds had been reluctant to discuss any bearish trades they made for fear of sparking protests from regulators who view the investors as vultures. On July 5, European lawmakers called for restrictions on traders' uses of credit- default swaps to profit from failures on sovereign debt they don't own. Credit default swaps are a type of insurance that makes investors whole if a borrower fails to pay.
Assessing Austerity's Impact