The sports car giant Porsche has pulled off one of the greatest share killings on record in a coup that has left some of the world's largest hedge funds nursing combined losses that could total $20bn (£12.6bn).
The vast sum was won and lost in bets on the share price of Volkswagen. While Porsche has been building a secret 74 per cent stake in its rival, the hedge funds have been betting that the shares will fall. The shares soared by 400 per cent in two days, leaving Porsche with a huge profit and the hedge funds – some of which are based in London – with losses that could drive them into bankruptcy.
City traders were stunned by the audacity of Porsche's move, although there is no suggestion that it broke German law or trading regulations.
The sudden rise in Volkswagen's share price – from about €200 to more than €900 – was triggered by the announcement at the weekend of Porsche's share-buying. The hedge funds had short-sold the shares – in effect a bet that they would fall – and so were left huge losses by the rally.
The Volkswagen debacle is the latest blow for hedge funds. In the boom years, these investors made dramatic returns – often on behalf of pension funds – by taking huge bets on a variety of financial instruments. But they have been hit hard by the credit crunch, with markets moving against them and banks increasingly unwilling to lend them money. Analysts at Morgan Stanley, the investment bank, last week estimated the global hedge fund industry could lose as much as $500bn in the value of funds under management in the second half of this year, with Europe worst-hit because of its reliance on short-selling.
They thought they were on to a sure thing with Volkswagen, given the crisis in the global automotive industry. Last week, VW's shares tumbled by a third in two days, and hedge funds piled into short positions, expecting it to be the start of a longer-term collapse in the share price.
"Last week when VW came down 50 per cent some people thought it was going to crash," said one market participant. "Some funds just said, 'it'll go all the way now it has broken through so let's get in (with a short position).'"
But they had not counted on Porsche's dramatic intervention. The maker of the iconic 911 and other sports cars had last year built up a 35 per cent stake in VW, but said at the time it had no plan to buy a majority of the maker of Golf hatchbacks.
Then in March this year Porsche's supervisory board gave the go-ahead to raise its VW voting stake to more than 50 per cent and thus make the world's third-largest car maker its subsidiary. But the company denied reports that it was interested in more control, saying this "overlooks the realities in VW's shareholder structure," adding the probability of gaining control of 75 per cent was "extremely low". Hence the hedge funds' belief that VW shares would fall still further – and the stunned reaction to Sunday's announcement that Porsche controlled 74 per cent of VW's shares.
The secretive nature of Porsche's share buying has raised eyebrows, but the authorities in Germany seem untroubled by the car-maker's tactics.
German regulators said yesterday they were examining trades in VW shares, but not the role of Porsche.
"First of all we will check trades in shares of VW to find any points that refer to possible market manipulation or insider trading. We are looking at the whole process," said a spokeswoman for BaFin, Germany's financial markets regulator. "That is the first step. If we find points that might look like market manipulation or insider trading then we will launch a formal investigation."
"We vehemently reject the accusation of share-price manipulation," a spokesman for Porsche told Reuters, adding that the market seemed to have mixed up cause with effect. He said: "The ones responsible are those that speculated with huge sums of money on a falling Volkswagen share price."
Porsche, with Wendelin Wiedeking at the helm, added that it would push for control of the company.
The hedge fund industry has seen huge growth over the past few years, with many ambitious young entrepreneurs, including Nathan Rothschild, opting to enter the sector. It also poached many senior investment bankers and private equity executives, attracted by the high returns and pay, and relative freedom of working for what are normally small firms.
Hedge funds thought they could outperform traditional investors by using increasingly exotic ways of investing their money. They also presented themselves as slight rebels, different from the staid financial establishment, often opting to set themselves up in Mayfair, west London, rather than the City or Canary Wharf. There will be those in Germany who will relish the discomfort of the hedge funds. In 2004, a German politician, Franz Muenterfering, described private equity firms and hedge funds as "locusts".
Betting on failure: What is short-selling?
* An investor borrows shares or other assets from the owner
* The shares are sold on the market in the hope that the price will fall
* The aim is to buy back the shares at a lower price. The borrowed shares are then returned to their owner
* If large numbers of traders short-sell a stock, this can lower the price
* Short-selling can help the market by reducing the price of an over-valued share to a realistic level