Nearly a decade into what feels like a never-ending bull market, it is getting awfully lonely for a group of maverick hedge funds betting on what they think will be a coming financial meltdown.
“If my analysis is right, we’re past the point of no return,” said Francesco Filia, founder of $500 million London-based Fasanara Capital, who has pivoted his $100 million macro fund to bet on a market crash. “Nothing else will do than having cash or shorts,” he said.
So far, Mr. Filia’s analysis has been painfully wrong. His fund has shrunk to around $100 million from around $160 million. Mr. Filia and his ilk believe a decade of central-bank bond-buying, known as quantitative easing, has artificially inflated asset prices and created huge market distortions. Moves in the U.S. to raise interest rates and cut bondholdings and in the eurozone to stop QE could, they think, provide the catalyst for disaster.
It also has become an increasingly controversial trade as central banks have slowly tightened monetary policy without causing a crash. The Federal Reserve began shrinking its balance sheet nearly a year ago. The European Central Bank has reduced new bond purchases already and plans to end them completely this year.
Speculating against a widely held market consensus can mean a lonely—and often painful—road.
“Pretty much immediately when we went more bearish we started to see the funds going out,” said Mr. Filia.
His bet lost money in some funds in 2016 and 2017—while the S&P has risen steadily. He blames a “sugar rush” as President Trump’s tax cuts extended the bull market.
Crispin Odey, founding partner of Odey Asset Management, thinks the bull market is “old.” He has been running an overall bet against stocks whereby his bets on falling prices—including bets against Tesla and retail stocks—have exceeded bets on rising prices by around 30%. That has contributed to three years of losses, including an enormous near-50% loss in 2016, although this year the fund is sharply up.
Clients have fled: His European fund, which was around €1.7 billion ($2 billion) four years ago, has shrunk to around €200 million.
Russell Clark, the main manager at London-based Horseman Capital, which runs more than $900 million, has been running a large position on falling U.S. stock prices including bets against technology and real-estate stocks. He describes quantitative easing as a “disastrous policy,” because it can prove impossible to escape.
These managers’ bets echo bearish positions taken by a small group of managers before the financial crisis. They were ridiculed early on but once the full force of the market and economic damage was understood, they made a killing and were hailed as whizzes. This time, however, the market has so far given bears little reason for cheer.
Few investors have backed up bearish views with large negative bets.
Elliott Management Corp. told investors it was preparing for stocks and bonds to “take a notable dive.”
But rather than talking about large outright negative bets, Elliott said it was preparing buy assets once they’d fallen in price.
Mr. Filia became convinced around mid-2016 that risks in markets had grown. QE is “a bit like the magic flute,” he said. It leads investors into crowded trades—bets on low volatility, rising prices and following trends—that can go badly wrong if the market changes direction suddenly.
Whereas the 2008 crash was centered around banks, risks today have moved to markets, Mr. Filia believes, which exist in a fragile state that is creeping closer to the so-called “edge of chaos”—their breaking point. “Now we think the awakening from the QE sleep is going to be very violent.”
His fund is positioned for a crash. One part bets on falls in stock and bond futures, while another two bet on stock and bond options. A fourth portion bets against exchange-traded funds, which he considers a key weak point in the financial system, when markets turn (Mr. Filia profited from the collapse in volatility note the XIV in February). A fifth part uses artificial intelligence to calculate when the market is likely to move sharply lower and then profit.
“I’m one of the few to be putting my money where my mouth is,” he said.
Horseman’s Mr. Clark thinks the U.S. corporate bond market and volatility-selling markets are “unsustainable” and that investors’ positioning in the face of slowing growth is “dangerous,” according to letters to clients reviewed by The Wall Street Journal. He declined to comment.
Many investors have lost patience with performance. Mr. Clark was running $1.7 billion at the end of 2015. Redemptions have helped slash this to under $800 million.
“I have a natural tendency to attack consensus positions,” he said.
—Rachael Levy contributed to this article.
Write to Laurence Fletcher at [email protected]