Cool ride on a historic rollercoaster

Guy de Blonay, whose global financials fund has performed pretty well through the credit crisis, is also a hedge fund manager who concedes that this time the short sellers have gone too far.

“This is history in the making.” Those are not my words, but those of Guy de Blonay, manager of New Star Global Financials, as he summed up the most tumultuous few days for decades in the financial markets. “It has been an incredible week, simply incredible.”

I caught up with de Blonay only minutes after the Financial Services Authority (FSA) announced it was calling a temporary halt to short selling. “That is obviously market- moving news and will change again the whole shape of the industry,” he said.

De Blonay manages hedge funds as well as his long-only £250m retail fund, but he still gave the ban a cautious welcome. “This market has completely been taken hostage by short sellers,” he said. “On a daily basis you were seeing a new victim. To bring a sick company to its knees is one thing, but to destroy healthy companies for a quick buck is another.

“I’m a hedge fund manager myself, and it will have an impact on what I do, but I can see the national interest and the ramifications for the wider economy. It will help stop a vicious cycle that is forcing one weak entity after the next to sell itself. At the very least it will delay the worst case scenario. Perfectly well financed and healthy companies such as HBOS should not be forced to sell themselves to a perceived fitter player.”

De Blonay’s fund has performed relatively well through the credit crisis, although that is against a benchmark (the FTSE Global Financials Total Return index) that has been shattered by events. The fund is down 28.8% over the past year but it just about keeps its head above water over three years.

But these are times when the figures are darting all over the place. As rumours of a giant American government bail-out of the entire sector gripped New York and London, bank shares enjoyed a startling rebound. As Fund Strategy went to press, the value of de Blonay’s portfolio would probably look very different by the end of the day.

During the hurricane that hit his sector, de Blonay has kept a consistently cautious stance. Only one-third of the fund is actually invested in banks. De Blonay has parked 25% in cash and bonds and has another 10% in the relative safe haven (until AIG) of insurers.

“I have been heavily invested in government bonds and have been holding a high cash position, but it is all relative,” he says. “In truth, there is nowhere to hide if you’re a specialist fund focusing on financials.”

He had no Lehmans, AIG, HBOS or even Lloyds TSB in his portfolio. Indeed, there are no British banks apart from HSBC – hardly regarded as a domestic UK play any longer.

“There’s still an awful lot of uncertainty out there,” says de Blonay. “Letting Lehmans go under may have been the right thing to do, but there remains a big question as to the impact that will have on the overall financial system in terms of unwinding contracts and deleveraging.”

The credit markets have effectively been frozen and it will take many more weeks to see if the latest bail-out will do anything to defrost them.

“Clearly the events of this week have been a crescendo in the constraint of liquidity – the worsening climate in the credit markets has indicated this in the recent past, but equities have taken some time to catch up,” says de Blonay. “With financial companies unable to tap the credit markets for funding, what are the alternatives in order to survive?”The first option, he says, is for banks to sell non-core assets. But as the Royal Bank of Scotland found when it tried to offload Direct Line, there are few buyers, given the view that these assets will get cheaper.

The only other option, as we have seen with HBOS, is to break up or merge. “Lehmans’ going into administration has further deteriorated the situation in the credit markets and the likelihood is that more mid/small players will fail as they have no access to capital in order to shore up their balance sheets,” de Blonay says.

Larger institutions have a greater chance of survival through increased access to wider deposit franchises.

“I predicted, going into September, that as long as the credit market is closed and liquidity is constrained there was always a high probability of these types of events and extreme volatility to persist in markets,” says the New Star manager. “Consequently, the fund remains extremely defensive in this environment, with a focus on companies with strong retail franchises, no exposure to investment banks and healthy, strong balance sheets that can take advantage of opportunities as they present themselves.”

His largest holding is HSBC at 6.3% of the fund. And it has been a massive tactical move – until very recently the bank did not feature at all among his major holdings.

“You have to look at the big picture. HSBC is the strongest bank of them all. It is the largest and healthiest in the UK and probably in the world. Unlike Citigroup, they are the richest in terms of deposits, and are very well diversified. If they have problems, then the whole world is having a problem.”

When the storm is over, the only place to be, according to de Blonay, will be in companies that have the capital to snap up walking wounded. “I will continue to try and avoid any companies involved in large and expensive acquisitions in the last two years as they simply won’t have the capital to take the business forward.”

He expects the market to turn its attention away from the issue of write-downs (impossible to predict), and focus on the macro environment and how a business will survive in 2009.

“My biggest challenge is being fundamentally right about the economy but suffering from unexpected directional moves as a result of market intervention because it is very difficult to predict what governments are going to do in terms of supportive action.” His conclusion? “While liquidity remains dry, I will remain cautious.”