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Dymon bets on cheap tail risk amid market complacency

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Danny Yong,chief investment officer of Dymon Asia, believes interest rate and currency options are underpricing risks and recommends owning gold or its call options as a hedge.

Hong Kong

DYMON Asia Capital (Singapore) is positioned so that almost one-third of its macro hedge fund's portfolio would benefit from black-swan market events and dislocations, chief investment officer (CIO) Danny Yong said.

The rising popularity of passive and algorithm-driven investing has helped fuel "enhanced market complacency", Mr Yong said in an interview with Bloomberg Television. While outsized market moves are becoming less frequent, the next major correction could be as big as the global financial crisis, he said.

"In the past, you see dislocations maybe twice a year. But now it may end up being more stretched out where it would be two years or three years before you see a big move," the CIO said. "If and when that happens, my belief is it will be a lot larger than it used to be."

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Dymon is investing in interest rate and currency options that Mr Yong believes are underpricing risks, such as US-China trade talks falling apart and the Federal Reserve being forced to cut rates further. He also recommends owning gold or call options on the metal as a hedge.

Dymon has assets under management of about US$5 billion, with around US$1.5 billion of that in its main Dymon Asia Macro Fund. The firm started out in 2008 with US$113 million, and attracted Tudor Investment Corp as its first outside backer.

Because of the built-in leverage of options, Dymon Asia Macro Fund would lose no more than 3 per cent of its assets if the market dislocations do not happen.

The firm's macro fund may hold even more so-called tail-risk or dislocation-type investments at various points, the CIO said Monday in Singapore. Such bets don't necessarily represent a bearish view on markets, but rather whether the securities are appropriately priced in the likelihood of market events.

"We're in an environment where things feel very stable, ironically, at least in the financial markets, whereas politically, things feel very polarised and unstable," said Mr Yong, who earlier in his career traded for Goldman Sachs Group and Ken Griffin's Citadel Securities. "Every portfolio should look for ways to hedge the tails, or in our case where we look to profit from certain outsized moves or breakouts. I think it's important to look for undervalued options."

What he is preparing for is the chance of a global economic slowdown triggered in part by the Trump administration's tough stance on China. Without a trade deal, China would be forced to cut interest rates, resort to more fiscal stimulus and possibly begin quantitative easing, boosting domestic stocks and bonds and weakening the yuan. Other regional currencies such as the South Korean won, and the Taiwanese and Australian dollars, would decline.

"It's becoming more clear to us that it's evolved from an 'America First' policy to a 'China Last' policy, so our view is they will continue to put a lot of pressure on China," Mr Yong said.

The search for yield in a low interest rate environment, fear of missing out in a rising market and the disappearance of bank proprietary trading desks have all contributed to the broad investor complacency, he said. One tell-tale sign that markets are getting closer to the tipping point is European junk bonds trading at negative yields, he added.

While the "self-perpetuating" euphoria may continue for a while, the price divergence from market fundamentals can't be sustained, Mr Yong said. BLOOMBERG