Despite the €750-billion bailout, the future of Europe's economy depends partly on a group of supposedly ruthless traders branded the 'wolf pack'. Who are they, and do they deserve their new nickname?
IF HEDGE funds are seen as the malignant force in global financial markets, then bond investors have long been perceived as their more benign counterparts – or so it was until the arrival of the “wolf pack” and their much publicised efforts to sink the euro. But are global bond investors really holding Europe to ransom, as suggested by politicians, or are references to packs of wolves an attempt to deflect from the real problems at hand?
The “wolf pack” term was first coined by Sweden’s finance minister Anders Borg ahead of the EU’s €750 billion bailout package earlier this week. Borg said that the herd, wolf pack behaviour of the markets was going to “tear the weaker countries apart” and had to be stopped.
He was referring to investors selling out of bonds, or simply not buying them, which resulted in bond prices falling across the PIIGS (Portugal, Ireland, Italy, Greece and Spain) countries. As a result, the yield on such bonds, which is the return investors demand for holding the bond, rose dramatically, thus pushing countries such as Greece to the brink of default.
“When you push yields up you make it impossible for governments to borrow,” says Bernard McAlinden, investment strategist at NCB Stockbrokers. “The logical conclusion of the panic would have been for premature defaults of governments around Europe, causing a financial crisis again,” he adds. Indeed, he describes Ireland’s borrowing position, at the height of the crisis, as having looked “increasingly worrying”.
Given the parlous state of the public finances of the PIIGS countries, governments have increasingly been going to the market over the past two years, borrowing money from global investors in the form of government bonds. However, when the yields on these bonds rise significantly, as was the case last week, borrowing costs become more expensive, and in some cases prohibitive, leading to the spectre of default. After all, if a country cant borrow and its revenues are less than its spending commitments, then it has no way of meeting its obligations.
But is the wolf pack, the so-called band of investors pushing down European bond prices, really a nefarious force in global finance? As with most things, there is an element of truth in the analogy, says McAlinden, but he adds that when talk turns to conspiracy theories, it’s usually because someone is “in denial of the market telling you a real message that something is wrong”.
Remember when Anglo Irish Bank blamed short-sellers, which were betting on the bank’s share price falling, for the collapse in its share price? Well, some commentators say something similar is happening now, with politicians putting the blame for the mess that some of the PIIGS countries are in on bond investors.
According to Padraic Garvey, head of developed markets debt and rates strategy with ING in Amsterdam, there are two types of investor involved in the so-called wolf pack. “On the one hand, there are speculative-type investors, who don’t have a vested interest per se in Europe’s bond market. But, on the other hand, there are real money accounts, who were losing faith in the Greek story and the ability of Greek politicians to sort it out.”
So, while opportunistic selling may be partly to blame for recent events, typical, conservative bond investors – such as mutual funds, insurance companies, pension funds and central banks – have also been frightened, and have started looking for more security by selling out of beleaguered countries’ bonds, or not buying any more bonds. “Investors are saying ‘I’ll just get out ’til I find things calm down’,” notes Garvey. “It’s a little bit harsh to be calling the real investor base a wolf pack. It’s not so much a wolf pack as a herd of buffalo – there isn’t a malicious herd mentality.”
IN FACT, MOST IRISH PEOPLE will have an interest in bonds – and thus could be said to be part of the wolf pack - either through their own investments, pension funds or even day to day banking. If you keep your money on deposit with an Irish bank for example, it is likely that the bank has invested these funds in bonds.
Nonetheless, where there’s some truth in the wolf pack analogy is the ability of the herd mentality to put countries on the precipice of default. “These guys can drive valuations down to levels which are too low to be realistic,” says McAlinden, adding that, while he agrees that it is “exaggerated to say it’s a hedge fund type group coming in and shorting bonds”, nevertheless “anyone can come in and short them – it’s a mixture of the two things”.
Over the past year there have been reports of hedge funds – such as Paulson Co, Brevan Howard and Moore Capital – engaging in speculative activity regarding the debt of the PIIGS countries. And when the market moves strongly in one direction, investors tend to follow, with mainstream investors, such as PIMCO, also pulling back from troubled European sovereign debt.
“The herd mentality is very much part of it. The fact remains that, if a decent rump of investors decide next week to sell Portugal, it will go down,” notes Garvey.
AND WHAT ABOUT Ireland? Could the wolf pack come after us? A sanguine Garvey doesn’t think so, saying instead that Portugal and then Spain would be the next likely targets. “Ireland is in pretty good shape,” he says. “In a sense it was tested in 2009 and passed the test. International investors have bought back into Ireland largely because it had already taken strong measures.”
And if the wolf pack is really just trying to protect itself and is not out for blood, the assertion that its behaviour is an attack on the euro is also seen as being misconstrued.
“It has been interpreted as an attack on the euro, but it was the market reappraising its view on what bonds are worth. It wasn’t a direct attack on the euro – but an attack on the value of the promise to pay from those governments. They just happen to hold the money in euro. If the same situation happened in California, for example, it wouldn’t be perceived to be an attack on the dollar,” says McAlinden.
With the bond market watching and waiting, it is crucial that the Government sees the Greek crisis as a warning signal. “It will be a mistake to see a facility of this size and think ‘now we don’t have to worry’,” says McAlinden.
Unfortunately for Ireland, that means another tough Budget is on the way.
The 'wolf pack': five of the world's most influential bond traders
WHAT IS A BOND?
For most investors, the main attraction of investing in government bonds – up until the current crisis at least – has been the security they offer. By investing in government bonds, investors are lending a government a sum of money for a specified time period. In return, the government will make regular interest payments to the investor, as well as returning the initial capital invested at the end of the agreed period.
The main risk for the investor is that the government will default – which is why so many investors fled Greek bonds – and will be unable to meet its obligations to investors.
FIVE BIG INVESTORS
PIMCO US
Fund manager PIMCO runs the world’s largest bond fund, the Total Return Fund, which has over $200 billion in assets under management.
PIMCO CEO Mohamed El-Erian has long been bearish on Greek bonds, believing prices will fall, and in late April said PIMCO had been quick to reduce its exposure to Greek, Portuguese and Spanish debt.
Paulson & Co
Founded by John Alfred Paulson in 1994, the hedge fund made its name globally by short selling subprime mortgages, generating billions in profit during the worst of the credit crisis.
It has been reported that Paulson took a similar position on Greek debt, with the firm identified by Greek intelligence as being engaged in speculative activity, aggressively selling Greek bonds, earlier this year.
Balestra Capital
Hedge fund manager James Melcher of US firm Balestra, is reported to have anticipated Greece’s problems back in 2005, buying credit default swaps (CDS), or credit insurance, on Greek bonds. It sold these swaps earlier this year at a higher price.
Artemis Investment Management
A UK fund manager, Artemis runs the Artemis Strategic Bond Fund, managed by James Foster. The fund bought Greek government bonds in February, before later selling for profit.
BlackRock
Unlike those selling Greek bonds, the world’s largest asset manager, BlackRock, went against the consensus, instead buying them up, with Michael Krautzberger, co-head of European fixed-income with the firm, declaring that Europe wouldn’t “allow a Lehman-type crisis”. However, he later told the Guardian that the yields, which is the return investors demand for holding a particular bond, of Greek bonds had gone “too high to stay too long”.
