April 22, 2018

Greenlight Capital’s David Einhorn Plays Europe’s Game

David Einhorn, the manager of the hedge fund Greenlight Capital, and an avid poker player, has wagered a safer bet on sovereign debt. European governments have rewritten the rules so that even if countries like Greece or Italy default on their debt, they won’t really default. That means that credit default swaps, which make money in the event of a default, don’t gain the way they’re supposed to. But in changing strategy, Greenlight Capital’s David Einhorn plays Europe’s game.

David Einhorn, an avid poker player, plays Europe's game in changing his sovereign debt strategy.

Einhorn invests in undervalued companies and is known for being a short seller, borrowing stock, selling it, hoping the price will go down, and buying it back later to realize a profit – the opposite of a “long” position. He famously bet against Allied Capital, Lehman Brothers, and most recently Green Mountain Coffee.

Bloomberg‘s Miles Weiss reports on the switch in strategy for sovereign debt.

Greenlight Capital held credit default swaps on $667 million of sovereign debt as of June 30. During the third quarter, the company exited about half of those swaps, designed to pay off should a government default, and entered into short sales on non-U.S. sovereign bonds, according to a regulatory filing.

By replacing the swaps with short sales, Einhorn maintained his ability to profit from a sell-off in government bonds while avoiding potential pitfalls that he identified in a July 7 investor letter. Greenlight wrote that regulators were seeking to prevent a triggering of credit default swaps tied to sovereign debt, in part because the payouts could devastate European banks that had agreed to provide the insurance.

“There are at least three or four fairly large funds that have done exactly the same thing as David Einhorn,” said Gary Swiman, who heads the asset manager and brokerage division at ICS Risk Advisors, a New York-based consulting firm. “You go from a private market that is unregulated at this time to publicly issued government sovereign debt that is transparent.”

The net amount of swaps written on France, Greece, Italy, Portugal and Spain declined to $66.8 billion at Dec. 2 from $74.5 billion at Jan. 7, according to data from the Depository Trust & Clearing Corp., a New York-based central repository for credit swaps. The largest reduction was for Greece, which had $3.4 billion of net credit swaps on its sovereign debt at Dec. 2, down 46 percent from $6.3 billion at Jan. 7.

The mark of a great hedge fund manager is to adapt to change. Many managers employ a strategy and stick with it even when the trade turns against them. Egos are at play. Einhorn is smart to realize the fundamentals of the trade are there but the events require a different route.

Greenlight compared the silliness of the euro zone’s refusal to classify a default as a default to the Belgian surrealist painter Rene Magritte’s “The Treachery of Images”. The painting depicts a pipe with a caption saying, “This is not a pipe”, meaning it was merely a painting and not an actual pipe. Going with the flow of the events surrounding his bet, Greenlight Capital’s David Einhorn plays Europe’s game.

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