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Hedge funds are holding out for further gains from their bets against JPMorgan's massive position in U.S. credit derivatives, racking up tidy profits from a lucrative trade that could cost the U.S. bank more than $3 billion.
Managers - some of them ex-employees of the biggest U.S. bank - started betting in credit derivative markets, including on an index of credit default swaps against its constituents, during the first quarter, believing JPMorgan's huge positions had created dislocations in the market which would disappear over time.
Some of those funds are sticking with their positions just as the bank tries to unwind its trades, industry insiders say.
"It still looks relatively attractive, and (funds) are likely to think the trade can run further," said one hedge fund investor, who asked not to be named.
"There's been some booking of profit, which is good risk management. (But) exposure has (largely) been maintained. Once you hit your targets, if there still seems momentum in the trade and the valuation metric remains reasonable, you stick with it."
JPMorgan's losses come from bets tied to debt via an index known as CDX.NA.IG.9, which tracks credit default swaps on about 127 investment-grade companies in North America.
The layers of swaps became riskier as more were added, traders say.
However, with liquidity in credit derivative markets significantly reduced over the last few years, volatility could rise and funds are closely watching the ease with which they can exit their positions and book profits.
London-based CQS, run by Australian Michael Hintze, was one of the hedge funds on the other side of the JPMorgan trade, one source familiar with the matter said. CQS declined comment.
Meanwhile, Claren Road Asset Management - a firm with links to JPMorgan - has also profited from relative-value credit trading in recent months, two fund-of-funds managers said.
Claren's New York-based Chief Risk Officer Bryan Carroll is a former global head of credit at JPMorgan Fleming Asset Management and is manager of a $4 billion global high-yield fund. Portfolio manager David DePaolo is a former executive director in high-yield credit trading at JPMorgan Chase.
Executives at Claren were not immediately available for comment.
BlueMountain Capital, a hedge fund with offices in New York and London, was also among those on the other side of JPMorgan's trade, according to two people familiar with the situation.
The $6.5 billion firm was co-founded by Andrew Feldstein, a former managing director at JPMorgan who worked in several of the bank's derivatives and credit businesses.
Industry insiders say credit hedge funds who scour the market for mispricings initially put on the trade - consisting of a long position on the index and short positions on its constituents - after spotting a price anomaly and before they had detected JPMorgan's huge, isolated position.
Managers were also attracted by the so-called "positive carry" - the ability to earn more income from a trade than they are paying out.
Funds involved in the trade have made gains of between 20 and 70 basis points for their portfolios so far, the hedge fund investor said.
"I think some funds will make a reasonable amount ... (but) it's not (George) Soros against the Bank of England or (John) Paulson versus U.S. subprime," one of the fund of funds managers said, referring to some of the most profitable - and famed - hedge fund trades of the past 30 years.
"I'd have thought the people involved already have a position on... I think people are looking at what makes sense. Some people might think 'we can push it a bit'."