Gaia Capital, one of the larger hedge funds with $150 million in assets under management invested in Japan, has lost 75% of its assets after the earthquake, tsunami and nuclear power plant crisis. At the end of March, the fund had $92 million in assets. There was $32 million at the end of April due to losses and investor redemptions. Gaia had been successful in prior years, returning 36.1% in 2009 and 21.7% in 2010 but it all unraveled after the natural disaster. The losses were in derivative strategies such as swaps and put options. The fund had placed a bet that the Japanese market would remain in a trading range i.e. they were short volatility. As a result of the earthquake, the Japanese index, Nikkei 225, fell to 8,234.6. The expected trading range was between 9,500 to 11,000. Investors fled. When the fund tried to exit its positions, there was no liquidity. Gaia had to liquidate its positions at the bottom of the market.
Shorting volatility is exposed to event and/or tail risk. A large downward move in the market causes large losses for the fund.
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