Hedge Funds Take Another Look at Greek Debt

LONDON — Twice burned, once shy?

Maybe not for hedge funds looking to make money in Greek bonds.

Ever since last summer, when it became clear that private sector bond investors would need to take a loss to ease Greece’s debt burden, some hedge funds have been betting large sums of money on different outcomes. And for the most part, the funds have lost their collective shirt as the value of the investments sank.

Now their investment noses are twitching again, this time at the prospect of buying the cheapest Greek bonds on the street: long-term, local-law bonds that currently trade at 19 cents on the euro — a knock-down price that reflects Greece’s current condition. A number of funds of late have been assessing the debt as a potential investment, according to brokers and traders with knowledge of the matter.

Of course, the hedge funds are well aware of Greece’s woes, even after it was promised 130 billion euros in additional bailout funds this week.

But therein lies opportunity.

By buying these bonds and then swapping them for new longer-term Greek securities when the debt restructuring takes place next month, they stand to make a quick profit. Traders and analysts expect the new bonds to have a market value of 26 to 30 cents. As a bonus, the exchange would also include two-year bonds issued by the Europe Financial Stability Facility, the European rescue fund backed by guarantees from Germany, France and other euro zone countries.

“It’s a perfectly decent trade, although you will need broad shoulders given the risk,” said Gabriel Sterne, an economist at Exotix, a London-based boutique bank that specializes in trading and analyzing distressed debt. “Let’s say you buy at 21 and the deal goes through at 27 — that is a 28 percent return.”

To a certain extent, the trade mimics the first one put on by funds last summer when they bought bonds at 40 to 50 cents, hoping to swap them for new securities worth about 80 cents. They were burned, however, when Europe scrapped the first 20 percent haircut proposal for a much deeper one, sending the bonds to their current rock-bottom levels.

More recently, funds scooped up billions of euros of bonds maturing on March 20 in the 40-cent range, expecting Europe’s bailout of Greece to include funds to repay these bonds in full. With that prospect no longer likely, these bonds have been falling too, and now trade in the low 30s.

This latest trade carries profound risks as well. While the new bonds might hit the market at 27 cents or so, there is no guarantee that they will stay at that level, let alone appreciate in value — especially if Greece’s economic prospects continue to deteriorate and the country has to either restructure its debt again or default and leave the euro. And if the new bonds plummet in price, unloading them will become nearly impossible.

But the upside may be too tantalizing to ignore, given the short time frame involved (the deadline to get the deal done is March 20, when Greece faces a 14.5 billion euro bond repayment) and the potential return (possibly 28 percent in less than a month).

Moreover, if investors pile into the bonds and then agree to the swap, the chances improve that enough investors vote to participate in the transaction so that it actually takes place. That would make the trade a win for speculators as well as for Greece, whose debt will be reduced by 100 billion euros if the deal is completed.

In many ways the investor interest is a sign that the debt restructuring — without which Greece will certainly face a chaotic default — has a good chance of succeeding.

The latest sign is the draft of a collective action clause law that is expected to be passed by the Greek Parliament in the coming days. Known as a CAC, this clause is being attached to existing Greek bond contracts, giving Greece the right to force all investors to accept the 75 percent loss on their holdings – even those who choose to spurn the offer.

A CAC can be imposed only after it has become clear how many investors want to swap their bonds and how many will choose to opt out. Greece — in setting a participation threshold of 66 percent — is more or less indicating that it believes that percentage of investors will participate. Once that many vote to accept the terms, minority investors will be forced to share in the losses.

“My bet is that the reason they have set the threshold at 66 percent is because they believe they can meet that easily,” said Mitu Gulati, a sovereign debt expert at Duke University Law School. “No one wants this deal to fail.”

That especially applies to hedge funds holding Greek bonds.