Hedge Fund's Gutsy Bet on Fed Hikes Pays Off With 20% Gain

(Bloomberg) -- A gutsy bet on Federal Reserve rate hikes propelled Kyle Shin’s hedge fund to a 20 percent first-quarter gain, backing up last year’s market-beating performance.

More than half the gain at Shin’s $467 million KS Asia Absolute Return Fund came from swap trades that profit as investors bet on more Fed rate increases this year than the two that were priced in as of December, Shin said in an interview. The Fed raised rates last month and two further quarter point increases are fully priced into the market, with a fourth seen possible.

Hedge Fund's Gutsy Bet on Fed Hikes Pays Off With 20% Gain

The trades helped Shin’s Hong Kong-based Gen2 Partners outperform in a quarter when global hedge fund returns were flat. The Eurekahedge Hedge Fund Index fell in February and March -- the first consecutive monthly declines in two years -- amid escalating trade tensions and forecasts for slower economic growth.

Hedge Fund's Gutsy Bet on Fed Hikes Pays Off With 20% Gain

To wager on faster U.S. rate hikes, Shin in mid-December entered swap arrangements in which he would make fixed-rate payments to his counter-parties in exchange for receiving floating rate payments, he said.

A two-year swap with annual payments bought then would have made a 0.8 percent return on its notional value by the end of March, according to Bloomberg calculations. So, a $10 million swap would have earned more than $33,500, according to Bloomberg analytics. Shin said he’s holding on to the swaps.

Flatter Curve

Shin’s trade was a variation of the bet on a flatter yield curve as the gap between short- and long-term U.S. interest rates narrows. He refrained from wagering on 10-year rates, because, he says, a 10-year Treasury yield above 3 percent would lead to a stock market crash.

The spread between 2- and 10-year U.S. Treasury yields is near the lowest in more than a decade as investors price in a steeper pace of Fed tightening, while the unemployment rate has dropped the lowest since 2000 and inflation is creeping higher. Stubbornly low long-term yields could eventually force the Fed to slow down, unless policy makers are willing to push the curve below zero.

Shin, the former South Korea research office head at Kingdon Capital Management LLC before striking out on his own in 2008, last year returned 56 percent, helped by a credit default swap bet that investors had underpriced South Korea’s default risk amid escalating tensions with the North, while over-pricing China’s risk of default.

©2018 Bloomberg L.P.