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Mutual Funds Hedge Bets as Poll Shows Narrow French Election

Four candidates, including far-right candidate Marine Le Pen, are in contention for the first round of the French presidential election, triggering a rush of insurance bets at investment firms.

Mutual funds are strengthening defensive positions ahead of the first round of the French presidential election, despite Thursday’s rally in financial markets.

Portfolio managers say the likelihood of a larger-than-expected majority for an anti-European Union candidate remains too high to ignore, even amid narrowing government bond spreads, rising French stocks and a strengthening Euro Thursday. They’re using defensive hedges such as short sales and put options to help protect their holdings should far-right candidate Marine Le Pen and far-left candidate Jean-Luc Mélenchon advance to the second round.

In an interview, Etienne de Merlis, chief investment officer at Signia Wealth, said he has witnessed an increase in the number of short-dated put options being traded on the Eurostoxx over the past few days. The rise in short-dated put options, which allow investors to sell an asset at a future date at a price agreed in advance, shows “a lot of people are hedging themselves” for market volatility, according to De Merlis.

“People are right to be cautious,” Andrew Mulliner, a fixed-income portfolio manager at Henderson Global Investors, said in an interview. The first round is now “too close to call.”

A poll released Thursday by Harris Interactive shows that four candidates remain separated by six points for the election taking place Sunday, a narrow spread that has buy-siders concerned that the margin for error makes the outcome too difficult to predict. The poll, conducted April 19, places social liberal candidate Emmanuel Macron three points ahead of Le Pen. Jean-Luc Mélenchon is now on a par with Republican nominee François Fillon in third place.

Mulliner said while the prospect of a Le Pen victory – in his mind – was unlikely, and a French retreat from the European Union unrealistic, he still is expecting volatility in the days ahead. The error margin of pollsters is a concern for fund managers, who point to Brexit and the U.S. election as examples of polls failing to accurately predict voting results.

On Thursday, the euro climbed to a three-week high against the U.S. dollar, or $1.07 per euro, suggesting increasing confidence in a positive, predictable outcome. A victory for Macron and Fillon in the first round would likely result in a good day for risk assets on Monday, according to fund managers. Macron and Le Pen reaching the second round would also suit those with bets on risk assets, as polls suggest Macron, who is pro-E.U., would defeat Le Pen should they both reach the second-round vote on May 7.

While Mark Dowding, co-head of Investment Grade at Bluebay Asset Management, says hedging risk is understandable, he warned that the defensive position many funds are taking could lead to widespread losses after Sunday’s vote.

“Markets have approached this vote with a degree of caution,” he said in an interview. “A lot of people are positioned short, and I think they will get really hurt on Monday. I don’t know anyone going into this long, super-convinced they can load up on risk.”

Still, Hartwig Kos, co-head of multi-asset at SYZ, maintains that the positivity in European markets on Thursday was an “underestimation of the tail risks.” He said his portfolio is “fairly defensively positioned.”

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