The China market chaos has made this hedge fund its most money in 2 years

Not everyone loses money when the markets fall.

Take 36 South for example. The London-based hedge fund’s Black Swan strategy gained 234% in the chaos following the collapse of Lehman Brothers in 2008, and the firm is back making money today.

Co-founder Jerry Haworth said the hedge fund has had its “best performance in a couple of years” betting big on spikes in volatility. And he didn’t have to time the market to do it, having laid down traps for panicking markets already.

“As for the reason for equity markets current fall, it’s like one more snowflake. Why does that particular snowflake trigger an avalanche? Who knows.” said Haworth in an interview today. “We put in position with predetermined profit stops — like volatility traps. We don’t necessarily have to be here to actively manage our positions.”

The VIX, a measure of market volatility known as the fear index, has been on a tear recently in response to China’s stocks rout. Chinese markets have crashed 15% in two days. It is the largest two-day fall seen since December 17, 1996.

Here’s the VIX:

The fund capitalises on the reluctance other market players have to hedging their own bullish positions. It can buy protection against volatility cheaply, and then sell it back to the market when there’s an inevitable crash.

“People get complacent and don’t generally like to hedge, it’s like trying to sell asteroid insurance to the dinosaurs,” said Haworth. “Whenever we are at a secular low in volatility just before a strong move upwards we tend to observe volatility falling strongly. It’s like a tsunami — the water recedes first before the tidal wave comes.”

It’s not a strategy for the faint-hearted though, especially when central banks are keeping monetary policy loose to avoid the types of crashes 36 South thrives on.

“It sounds easy but it’s quite difficult to do in practice. You make small losses, it’s like Chinese water torture, but it pays off big very quickly,” Haworth said.

The firm is betting on the potential for a complete global collapse, eclipsing anything investors saw in 2008. There’s a bubble of cheap credit out there, economic growth is difficult to come by and markets are jittery.

Firstly, China looks very shaky. “We think there’s the potential for a lot more to come down the pike. Just look at the McKinsey study. China’s debt went from $US7 trillion to $US28 trillion in the last five years so that gives you an idea of how much they had to inject in the system just to keep things running normally.”

If China goes, then the rest of the world could fall too.

“We personally believe this crisis has been building since 1987,” said Haworth. “It’s a credit bubble 30 years in the making and we can look forward to a period of sustained volatility.”

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