By GREGORY ZUCKERMAN
Some of the biggest U.S. hedge-fund investors have made billions betting against the yen, exploiting Japan’s determination to weaken its currency and boost its economy.
Wagering against the yen has emerged as the hottest trade on Wall Street over the past three months. George Soros, who made a fortune shorting the British pound in the 1990s, has scored gains of almost $1 billion on the trade since November, according to people with knowledge of the firm’s positions. Others reaping big trading profits by riding the yen down include David Einhorn’s Greenlight Capital, Daniel Loeb’s Third Point LLC and Kyle Bass’s Hayman Capital Management LP, investors say.
The growing trade has itself helped pressure the yen, which has slid almost 20% in about four months. That, in turn, is helping fuel what could become a world-wide currency war. Countries such as Germany and France have criticized Japan’s policies, while others have threatened to take action to reduce the value of their own currencies to remain competitive with Japan. Like Japan, many countries depend on exports, which are more profitable when their own currencies are lower.
Investors began jumping into the trade late last year, ahead of the election of Shinzo Abe as Japan’s prime minister. When Mr. Abe and others were unusually open in their rhetoric about driving down the currency, traders added to their positions, helping the yen weaken. Soon, salespeople and traders at banks were telling hedge funds and other investors that the time was right to make big bets against the yen.
Mr. Abe’s election, and the selling by hedge funds, had a big impact. On Wednesday, the dollar bought about 93 yen, from about 79 yen in mid-November. “It’s a bet on Abe-nomics” someone close to the Soros firm says.
Many others have come to the same conclusion. Among the most vocal proponents of the trade is Robert Ettinger, the head of Bank of America’s BAC +1.23%options trading group for currencies in the Group of 10, investors say. Mr. Ettinger has spoken about how he “loves” the bearish yen trade, according to an investor who heard him speak recently. Bank of America’s trading desk also has made money on the trade, according to people with knowledge of the firm’s positions. Mr. Ettinger declined to comment.
Few investors, though, have made as much money as Mr. Soros. The 82-year-old investor’s $24 billion Soros Fund Management has made close to $1 billion of paper profits since mid-November wagering on yen weakness, according to people close to the matter.
The firm, which returned cash to outside investors last year, still invests money for Mr. Soros and his family. It manages about $15 billion itself and allocates the rest to other investors. Soros Fund Management has been led since last summer by Scott Bessent, who increased the yen position late last year. The Soros firm also has done well owning Japanese stocks, which have been rallying. Japanese shares represent about 10% of the firm’s internal portfolio, according to people close to the firm.
Betting against the yen isn’t for the faint of heart. Japan had for years failed in its efforts to lower its currency and reignite its economy and stock market. Many who adopted short positions on the yen and on Japanese government bonds during that period got pounded when the currency and the bonds instead strengthened. Shorting Japan became known on Wall Street as a “widow maker.”
“You aren’t a macro trader if you haven’t lost money betting against Japan,” one trader said.
Knockout Punch
One popular way investors have been betting against the yen is by purchasing so-called reverse-knockout options. These options do well as the yen falls, but become worthless if the currency tumbles too much. The lid on profits made the option relatively inexpensive when it first came into vogue in November, especially among those who weren’t convinced the yen would show dramatic weakness that would render the option worthless.
The following is an example of how a reverse-knockout option with a strike price of 90, and a knockout price of 92, worked, step by step:
In November, investors paid to buy two-month reverse-knockout options.
On Jan. 18, the yen fell to 90 to the dollar, scoring big paper gains for those holding these options.
Those who exited the option at that level or rolled the options into other trades scored profits.
On Feb. 1 the yen fell to 92 yen to the dollar, making the option worthless for those still holding it.
Japan’s new economic policies are expected to be widely discussed at this weekend’s meeting of the Group of 20 finance ministers in Moscow. This week saw rocky trading in the yen after a series of conflicting reports about whether the smaller Group of Seven nations were supportive of Mr. Abe’s policy. After global criticism, Mr. Abe and his advisers have toned down their talk about weakening the yen. Instead, its central bank has promised a significant new easing in monetary policy by buying bonds—similar to strategies enacted by the U.S. Federal Reserve and the European Central Bank—which policy makers say is aimed at ending Japan’s long bout of deflation and often has the side effect of lowering a currency.
As quickly as investors raced to short the yen they could just as easily rush to end this trade, sending the currency higher again, especially if investors conclude the Japanese government is backing off its antideflation campaign.
The prospect of inflation in Japan as the yen weakens may prompt people to turn to gold as a currency hedge. The WSJ’s Clementine Wallop talks about what to expect from gold demand in India and China as well as Japan.
Some hedge funds already have been trimming their bearish yen positions. “People recognize there are concerted efforts on hand to end two decades of deflation,” Chris Ayton of Alternative Investment Group, which invests in hedge funds for clients. “But I don’t see genuine belief out there yet that this time is different. There’s still a significant amount of skepticism.”
It isn’t clear who is feeling pain as the yen falls. Some Japanese exporters with receivables tend to sell dollars and buy yen in the futures market, which could mean they currently are sitting on losses, some traders and analysts say.
“Japanese exporters need to buy yen, and they’ve been doing that a bit more recently, believing the yen weakness wouldn’t last,” says David Woo, Bank of America’s head of global rates and currencies research.
Shares of exporters have been helped by the recent rally in Japanese stocks, of course. The Japanese economy isn’t as export-dominant as it once was, reducing the impact of a falling yen, some analysts argue.
Unlike Mr. Soros’s early short of the British pound, the recent moves by Mr. Soros and other hedge funds are unlikely to destabilize Japan or its currency, partly because trading of Japanese yen is a deeper market that is harder for investors to dictate. Nearly all of Japan’s debt is owned by domestic investors, another reason short positions on the country by bearish investors haven’t had much impact.
At the same time, Mr. Soros’s gambit against the pound was in opposition to policies of the Bank of England, while hedge funds now are making trades in hopes the Bank of Japan succeeds in its policy of defeating deflation.
Lately, a rush of new investors has become involved in the yen trade. As more investors jump on the bandwagon and search for ways to place their own wagers against Japanese currency, some worry the latecomers may regret their newfound ardor for shorting the yen, much like those who piled into shares of Apple Inc. AAPL +2.64%just before its recent tumble.
Many investors bailed out of earlier bearish-yen trades a while ago, unable to withstand losses they suffered. It is similar to how some mortgage specialists removed long-held bets against subprime mortgages before the housing market finally weakened in 2007. They then missed out on the profits when the market turned.
Others, like Greenlight Capital’s Mr. Einhorn, have held on. His firm gained over 3% in January thanks in part to his yen bet.
“We put the trades on about three years ago and the trade wasn’t fun for the first two years and number of months,” Mr. Einhorn says. He expects further weakness.
Investors have wagered against the yen in various ways, from complicated derivatives to simple put options, the kind that Mr. Einhorn says he bought.
Others have had to switch gears, quickly. Bridgewater Associates, the world’s largest hedge-fund firm with $141 billion, had expected strength for the yen for most of 2012, but removed its bullish yen positions in the fourth quarter of last year. Bridgewater is “now modestly short” the yen, according to a January letter to investors.
Write to Gregory Zuckerman at gregory.zuckerman@wsj.com and Juliet Chung at juliet.chung@wsj.com
