Trying to dig deep and understand what happened between the 2nd and 5th of August of such magnitude to trigger a crash in Japanese markets worse than 1987, a name kept being mentioned: “Capula”.
Let me be honest, I have never dealt with this hedge fund before, and my direct knowledge as a consequence is quite limited, so I had to ask a lot of questions around.
First of all, let’s do some intro here. “Capula Investment Management LLP” is a hedge fund with ~30b$ AUM based in London and founded by Yan Huo and Masao Asai.
Yan Huo and Masao Asai were two former prop traders at UFJ who left in 2005 to start Capula, but they never parted ways for long with their former employer since in 2008 they sold a large stake to MUFG (born after the merger between UFJ and Mitsubishi Tokyo Financial Group) along with Goldman Sachs and Petershill (“Mitsubishi buys stake in Capula“)
During its 19 years of operations, Capula became famous for delivering high, consistent, and low volatility returns, especially in its flagship Global Relative Value fund, becoming a favourite investment choice especially among pension funds according to several past articles and disclosures. The hedge fund came under the public spotlight lately, something that happens quite rarely, for its considerable investment into the Bitcoin ETF (“London-Based Capula Investment Reveals $464M in Bitcoin ETFs“)
According to Capula’s latest 13-F filing, almost 40% of the portfolio is invested in the IVV ETF and 9% in SPY. Odd, isn’t it? However, what is even weirder is that Capula Japan Equity Tail Risk Master Fund Ltd has been among the first hedge fund “customers” to be granted direct clearing by Japan JPX in 2018 (Notification)
At the moment, 5 Capula funds have direct access as “customers” to JPX interest rate swap derivatives clearing:
- Capula Global Relative Value Master Fund Limited
- Capula Multi Strategy Master Fund Limited
- Capula Tactical Macro Master Fund Limited
- Capula Tail Risk Master Fund Limited
- Capula Volatility Opportunities Master Fund Limited
As you can intuitively understand, what’s the deal with a hedge fund mainly holding exposure to S&P500 and US large cap stocks (especially Amazon and Nvidia) being so large and active in Japan Interest Rates Derivative swaps to gain direct access into the clearing? If 2+2=4, it’s then obvious the name was engaging in JPY carry trades in a significant size. To be fair, Capula isn’t the only prominent hedge fund in JPX list; however, others haven’t been flagged as subjects of interest in the various conversations I had.
Now, we aren’t so naive to believe a hedge fund just holds half of its assets in the S&P500 outright, right? As a matter of fact, the fund in reality engages in long/short strategies to capture alpha (typical of hedge funds), but differently from the others, it is well known to be aggressive in leveraging via JPY carry trading. This was already the simple but profitable strategy already employed by the two co-founders back in their days as bank prop traders.
Based on several conversations I had, Capula might have exaggerated a bit too much with the leverage and got caught off guard in the latest JPY short squeeze efforts perpetrated by the BOJ and was “very busy” in unwinding positions until it all escalated on the 5th of August.
Do you remember we mentioned at the very beginning that Capula is a hedge fund operating from the UK? Well, as we saw last week, coincidentally “THE JPY CARRY TRADE IMPLOSION CONTAGION IS ALREADY SPREADING INTO THE UK“. Can Capula having issues to settle its large JPY derivative carry trade positions potentially be the reason why banks are rushing to fetch liquidity from the BOE short-term REPO facility (that was set up to supply emergency liquidity to the system in case of shortages) borrowing 38bn GBP, a fresh all-time high, in the latest round today?
Usually, where there is smoke, there is a fire underneath, and we are seeing a lot of smoke coming from the UK at the moment. Is Capula really the hot spot as I have been pointed to? Time will tell…
So JP Morgan (or was it Morgan Stanley) says last week that “70% of the JPY carry trades have been unwound”..But now I just hear from Dave Kranzler that the likely only carry trades that have been unwound were the most recent ones affected by the recent JPY interest rate hike, while most other trades have been in place for years and still have profitable spreads..Any truth to this you think?
Yep, smoke comes from fire but you would think these Japanese hedgies would have known about the rate hike and had time to unwind a bit. Super interesting research though and I think you might have found the tail of the fire breathing dragon..Going to be interesting!
the truth is a lot of hedge funds are more and more relying on their algorithms to quickly unwind their positions because if they start covering all the risks they are exposed to ex-ante their trades will be outright unprofitable. So yes the type of JPY carry trade unwind we saw so far was just the tip of the iceberg since decades of carry trades cannot disappear in 2 weeks in particular those exposed to illiquid fixed income credit positions. I do not agree old JPY carry trades are still profitable, that ignores the fact that with the global increase in interest rates the mark to market on the principal value of those position is now deeply under water