1998 LTCM Crisis Repeated? Large Losses for UK Hedge Fund Investing in Russian Government Bonds

[Photo by Reuters-Yonhap News]

[Asia Economy Reporter Park Byung-hee] It has been confirmed that London-based hedge fund Pharo Management suffered massive losses after investing in Russian and Ukrainian government bonds. Concerns are rising that the 1998 Long-Term Capital Management (LTCM) crisis, in which the U.S. hedge fund went bankrupt after huge losses from investing in Russian bonds, might be repeated.

According to major foreign media on the 3rd (local time), Pharo’s Gaia Fund, managing $5.2 billion (approximately 6.26 trillion KRW), recorded a 10.7% loss last month. Another macro fund of Pharo, managing $4.3 billion, suffered a 2.9% loss.

Pharo’s total assets under management amount to about $11 billion. Foreign media explained that Pharo’s asset size is among the top emerging market hedge funds worldwide and that Pharo is currently the most well-known fund struggling due to the Ukraine crisis.

Pharo’s Gaia Fund has recorded an annual loss only once since its inception in 2008, with an average annual return approaching 11%. The macro fund, established in 2005, has recorded annual losses twice and currently has an average annual return of 9.2%.

After Russia invaded Ukraine on the 24th of last month, Russian government bond prices plummeted.

According to Bloomberg, the price of Ukraine’s 10-year dollar-denominated government bonds fell from 86 cents per dollar in early February to 26 cents recently. Russia’s 25-year bonds also plunged from 110 cents per dollar to 20 cents. The prices of both bonds have dropped to levels indicating a very high risk of default.

The Nihon Keizai Shimbun reported that the credit default swap (CDS) premium rate (5-year) indicating the default risk of Russian government bonds exceeded 15% as of the 28th of last month. When the West imposed sanctions following Russia’s annexation of Crimea in 2014, the rate was only above 6%, but now it is more than twice as high, indicating a significantly increased default risk. The Nihon Keizai Shimbun also noted that nearly $135 billion, just under 30% of Russia’s external debt including corporate bonds, is maturing within one year, raising default concerns for the first time in 24 years since Russia declared default in 1998.

According to Hedge Fund Research, hedge funds have recorded an average loss of 1.8% from the beginning of this year through February due to the Ukraine crisis. To prevent further declines in Russian and Ukrainian bond prices, redemptions from funds with assets exceeding 4 billion euros related to Russia and Ukraine have been suspended in Europe.

Another London-based hedge fund, Amia Capital, also invested in Ukrainian government bonds and is reportedly experiencing mid-single-digit percentage losses this year, according to an insider.

As concerns over hedge fund losses grow, fears of a repeat of the LTCM crisis are increasing. In 1998, Russia declared a moratorium on external debt payments. That year, Russia’s consumer price inflation exceeded 80%, and its gross domestic product (GDP) shrank by 5.3%. LTCM, which had heavily invested in Russian government bonds, could not absorb the losses and was liquidated in 2000.

At that time, the U.S. Federal Reserve intervened to manage the crisis caused by LTCM’s massive losses by mediating a bailout from 14 Wall Street banks. Goldman Sachs, JP Morgan, and others provided $3.6 billion in support to LTCM. The Fed also cut interest rates consecutively to ease the crisis. The U.S. benchmark interest rate dropped from 5.5% in September 1998 to 4.75% in November of the same year.

Elima Rivakova, Deputy Chief Economist at the Institute of International Finance, predicted that Russia’s GDP will shrink by at least 10% due to the Ukraine crisis, expecting the situation to be worse than in 1998.

This content was produced with the assistance of AI translation services.