Nervous hedge funds managers are stress-testing their portfolios and searching for ways of protecting themselves against their worst nightmare -- a potential break-up of the euro zone, says a Reuters report.

With talks on restructuring Greece's debt mountain still deadlocked, and the exit of one of more countries from the euro seen as a small but definite possibility, funds are modelling scenarios ranging from a 50 percent slump in European stocks or a 45 percent fall in the oil price to a 30 percent rise in gold.     

Managers are also trying to dig out old computer programmes they once used to model the behaviour of currencies such as the drachma or the deutschmark as they prepare for an event for which -- even after the 2008 collapse of Lehman Brothers -- they effectively have no precedent.

Many, having already trimmed risk, are piling into credit default swaps or deeply out-of-the-money options, hoping they pick a counterparty that can withstand the shock of a break-up.     

'You can't conceive what this event will be like, but it doesn't absolve you of looking at it,' said the chief risk officer at one hedge fund firm who asked not to be named. 'People are asking the questions, 'do I have the historical records on how things worked when there was a deutschmark?' and 'did I throw away those computer programmes (modelling the deutschmark)?'.'     

Funds are also trying to figure out how they might be affected if different asset classes that normally have a low correlation start to fall sharply at the same time.

'Anyone who's a chief risk officer is running these scenarios -- say if the euro falls 15 percent, stocks fall 25 percent, if the possibility of default increases, what if recovery rates falls, which prime brokers, administrators get hit?' said Mark Wightman, head of strategy for Asia-Pacific at specialist technology group SunGard.

'The scenarios are getting quite complicated and people are starting looking at correlations between things to understand the likely impact.'     

While hedge funds, which can put on short positions, have more tools at their disposal than long-only funds to cope with market falls, their performance has been patchy.  Last year they lost just over 5 percent on average, according to Hedge Fund Research, while the S&P 500 delivered a total return of 2.1 percent. That was their second calendar year of losses in just four years after heavy losses during the credit crisis in 2008.     

Many hedge funds have already cut exposure to assets seen as directly in the firing line such as the euro or European stocks, insiders say, but are finding their options limited.

'We're all still trying to run our businesses right now. I'd like to say I'll put everything in US dollars, but you can't,' the hedge fund chief risk officer said. 'Part of it is contingency planning -- what you need to get out of first -- and part is proactive -- 'I don't need so much emphasis in a certain area right now', such as European stocks or the euro,' he said.  - Reuters