In Defence of Hedge Funds — Brexit.

The vast majority of opinion polls that became public in advance of the EU Referendum (Brexit) vote two years ago suggested that Remain would win. People could bet on that. There were spread betting companies and other bookmakers that took substantial bets on the result. The betting markets reflected the view that the most likely result was that Remain would win.

One of the key ways that fund managers could “bet” on the Brexit result was to take a position betting on the direction of the pound sterling. (Brexit positions were taken by market participants in other areas as well as directional ones on the pound, but for the purpose of this post, I will focus on the directional ones on the pound as it was indeed an important one). The view was that if the result was for Leave, the pound would drop substantially (and that is what happened), but if Remain won, the pound would do well. Market participants intent on expressing in a view in such a way could buy or sell pounds to reflect their view. Below I detail the closing value (to two decimal places) of the pound against the United States Dollar on each day (excluding weekends) over the crucial period in June 2016.

June 16, 2016: 1.42 USD
June 17, 2016: 1.44 USD
June 20, 2017: 1.47 USD
June 21, 2016: 1.47 USD
June 22, 2016: 1.47 USD
June 23, 2016: 1.49 USD
June 24, 2016: 1.37 USD
June 27, 2016: 1.33 USD
June 28, 2017: 1.33 USD
June 29, 2017: 1.34 USD
June 30, 2016: 1.33 USD

As can be seen from the above table, in advance of the vote on June 23, the pound crept up. This was as a result of the market become surer in its own mind that the Remain camp would win. Over the weekend on June 18–19 and on to Monday June 20, opinion polls came out suggesting Remain would win. The pound leapt. The vote itself was on June 23, 2016. On that day, the market increasingly expected Remain to win and the pound went up to over 1.49 vs the USD.

Away from simply betting in the foreign exchange markets by taking an outright position in a currency, hedge funds and other sophisticated market participants can take a position with options. One relevant option that people were interested were put options on the pound. The view, as the market became more and more sure that Remain would win, was that the pound did not have that much further upside if Remain won, but, on the contrary, if Leave won, the pound would fall massively. Buying put option on the pound enables market participants to bet that the pound will fall while at the same time limiting losses if the pound rises.

Options also enable market participants to have exposure to much bigger position sizes if they so desire. The strategy can be very risky and nobody should try it without fully understanding the risks. However, what it does mean is that a hedge fund with, for example, $1 billion of investors’ money can take, if it is within their mandate, notional position sizes much greater than the $1 billion capital they have. Options can be a good way of leveraging a view.

For completeness, one can note that options are not always used to increase exposure: they are often used by fund managers and others as a method of protection. Let us say a fund manager had substantial exposure to the UK stock market. And let us say they felt that if Leave won, both the UK stock market would fall and the pound would fall. The combined effect would create a huge loss for investors in their fund. They might have purchased a put option on pound to hedge against that risk. Looked at this way, the option is like buying insurance on your house burning down in a fire. You hope that your house does not burn down, and that the insurance premium is wasted, but just in case it does, you will get a large payment from the insurance company to reimburse you for the losses sustained.

Without trying to get too technical, the greater the amount of expected volatility, the higher the price of an option. The market is not stupid. It knew there was the vote and it knew that there was a possibility of an extraordinarily large move in the value of the pound. The market gave the pound a very high implied volatility for options on the pound that extended over the period of June 23–24, 2016. This meant put options on the pound covering those dates were very high priced. But on the day of June 23, the day people were voting, but before the result was known, something quite dramatic happened to the price of options on the pound: they started to fall. The reason for this was that as the market became increasingly convinced that Remain would win, the expected “shock” of Brexit seemed less likely and hence the chance that the put options purchased when the volatility was high would make money for the holders diminished. The market anticipated a lower chance of Brexit. As such, very high priced options became less attractive and the price fell. They remained high priced, but it is all relative and betting on Brexit at 9.00pm London time on June 23 by using put options on the pound was much cheaper than it had been 12 or 24 hours hours earlier.

By the time of the vote, a victory for Remain was well expected. Numerous opinion polls pointed to such a victory. On the day of the vote, The Independent declared:

Election forecasting experts said that for Leave to win now, it would represent an even bigger polling error than was seen ahead of 2015 or 1992 General Elections.

We know what happened overnight. Confounding the predictions, Leave (Brexit) looked increasingly likely to win and finally did win. The pound tumbled. Many people lost fortunes, but some who had purchased these high priced put options made a fortune. And for many who made money on options betting on the pound, they lost money in other areas. The puts on the pound were a hedge against other positions. Hedge funds get their name because they can hedge exposure.

That was two years ago.

Yesterday, Bloomberg published a feature article by three journalists explaining that “hedge funds used private polls to make millions.” A key part of the article is about what Nigel Farage, the then leader of the UK Independence Party (UKIP), did or did not know at given times and what he said to the press. Here, I am mainly interested in what the feature said about hedge funds. Summing up, there are a number of allegations:

1. Hedge funds contracted with polling companies for private polls in order that they could have a greater confidence in their predictions of the Brexit vote. Polling companies might have streamed data by the hour on June 23 to their hedge fund clients.
2. At least one hedge fund had staff from an opinion polling company in its offices through the night on June 23–24 feeding information to analysts of the fund their assessment of the likely result and the probability they would ascribe to it.
3. As a result of information from 1 and 2 above, the hedge funds might have had a time advantage, over the television networks, on assessing the probability of the Leave vote winning had greatly increased. They would not have needed long. They could have heavily sold the pound before it collapsed and massively profited when it did collapse when the information that they had became more widely known. It should be noted that the Bloomberg story does not specifically allege that the information fed to the hedge funds from the private polling did point that way, although it does suggest that at least one, Survation, did correctly predict the result. It is entirely possible that some hedge funds paid over vast sums of money to polling companies who told them them Remain would win.
4. Hedge funds might have commissioned polling companies in the run up to the vote to carry out polls in advance of other polls that they were publishing. Since the pound could easily move on the result of a public opinion poll, if a hedge fund manager could predict what the results of the opinion poll would be before it was published, it could make a short term trade to profit when the opinion poll was published.
5. Hedge funds might have paid for the raw data from polling companies, not made available to the general public, and carried out their own analysis on that data. They might have had their own models which were more sophisticated that the polling companies models to make their own prediction on the result with a greater level of sophistication than the polling companies.

If I just stick with the five points above, the Bloomberg story is reasonable. If there is any surprise, it is that a similar article was not published within a few weeks of the June 23, 2016 referendum.

Hedge funds have done nothing wrong by commissioning polling companies. It is just analysis. Trying to predict what will happen is what fund managers and investment analysts do all the time.

Taking a simple example, there is nothing wrong with a fund manager sending an analyst to Marks and Spencer flagship store at Marble Arch, in the heart of London in the week before Christmas to walk around the store looking to see if customers are filling their shopping baskets and queuing up to pay, or whether the store looks surprisingly empty for that time of year. The purpose of asking the analyst to do that is try and predict whether the Christmas sales figures were good before the company makes an official announcement on sales figures. If the fund manager can get it right, he or she might be able to outperform other fund managers by buying or selling shares in Marks and Spencer. Such activity is very different from what would be illegal: being tipped off by a director of Marks and Spencer, who has the information on the company’s sales figures, as to what sales were and trading on that information before it is in the public domain. Fund management companies often market themselves as having great fund managers who have good market insights. Utilising private polling to assist is a sensible strategy: it is not subterfuge.

So that is Bloomberg. What about journalists elsewhere:

Hugo Rifkind, a columnist for The Times, said on Twitter in relation to an LBC news story on the matter:

The bit about knowing of polls before they become public and trading off them is vital. This is a fucking sewer.

This is not what is alleged. If polling companies had provided information on public polls to hedge funds before they made them public and the hedge funds traded on the information, it would be a more questionable activity, but Bloomberg does not make that allegation. The closest is that the hedge funds might have commissioned other polls to try and predict the result of the public poll. There is a substantial difference between using the knowledge of private polls to predict public polls and having advanced knowledge of the result of the public poll.

Nick Cohen, another journalist for national news publications, said on Twitter in relation to the same LBC news story:

The Brexit vote was spun so hedge fund managers could clean up. I wonder when, if ever, 17.4 million of our fellow citizens will realise that they’ve been played

There is nothing in the Bloomberg story or the LBC news report on the matter that justifies such a tweet. I am at a loss as to what made Nick, a columnist whose work I admire, write that. It is based on fantasy.

The television personality and author, Robert Peston, linking to the Bloomberg story, used his Twitter account to say this:

[It] looks like market manipulation on the night the UK chose Brexit — and Sterling first rose and then slumped

This is a very serious allegation, but there is nothing in the Bloomberg story to justify it. The facts that sterling rose and then slumped and that hedge funds used private polling do not themselves imply that anyone manipulated the market. If someone wanted to make the allegation that hedge funds had advanced information on polling, provided that information to Nigel Farage, and asked/paid him to lie and claim that that Remain was winning, then perhaps Peston would have a case for his Tweet. But that series of events is no more than a conspiracy theory. Moreover, hedge funds with good polling information that predicted the result would not have needed to do that. They could have just sold the pound.

It was well discussed in the financial markets that hedge funds were using private polling. If one hedge fund had very good information from a polling company prior to 10.00pm that a Leave vote was the likely win, it is difficult to conclude that they would have waited before selling the pound on the hope that Nigel Farage, with their encouragement, would mislead the market about the results of the private poll in order that sterling would would go higher and they would have a better opportunity to sell. A key reason for this is that the hedge fund in question would likely be aware, or at least guess, that other hedge funds were also using private polling. While they were waiting, another hedge fund, now with similar information from a different polling company, could steal a march on them and heavily short sterling and move the market confounding their strategy. There was a mass of profit potential by shorting the pound at 9.45pm, one did not have to wait for it to go higher. It is feasibly possible that a hedge fund got Nigel Farage to lie in order that others would buy the pounds they were selling thus preventing the fall in the pound while they were selling, but this is just pure conspiracy theory speculation, and again, it was not necessary for the hedge fund to do that. The likely fall in the pound if Leave won was so far, they would not have need to do this to make a fortune from selling the pound.

Carole Cadwalladr , a writer for the Guardian and the Observer, declared on Twitter:

In summary, @bloomberg describes the referendum as a financial heist. The biggest insider trading job in history when pollsters colluded with hedge funds to create a fake bubble that was burst by a fake concession ..delivered by friend of the people, @Nigel_Farage.

Again, this is just fantasy and not an accurate summary of the Bloomberg story.

Away from the journalists, I cannot resist mentioning Gina Miller, who initiated a legal case against UK invoking Article 50 to leave the EU without parliamentary approval. She linked on Twitter to the Bloomberg story and said this:

BREAKING NEWS: The Men Who made Money From Brexit and will continue to get richer whilst ordinary Brits get poorer.

This can only be described as chutzpah given Gina Miller’s husband, Alan Miller, was not only a hedge fund manager, he was given the label by the Daily Telegraph as the original “Mr Hedge Fund.” Gina Miller has also said on Twitter, with a link to the Bloomberg story, “WARNING: Insider dealing.” Perhaps Gina Miller should have the term “insider dealing” explained to her by her husband before she makes such allegations unjustified by her source.

Finally, information from opinion polls is not knowledge of a result. Opinion polls can suggest a likely result that turns out not to occur— as most of the polls on the Brexit vote in the UK, and the 2016 Presidential Election in the USA demonstrated.