March 14, 2013 5:27 pm

Hedge fund makes waves over London Whale episode

Andrew Feldstein of BlueMountain

Andrew Feldstein sees a bit of Ulysses in him - although he wants to hear sirens singing, he will not do anything foolish and crash his ship

In the hard-bitten Detroit of the film 8 Mile, the protagonist played by musician Eminem wins an expletive-filled rap “battle” in a dingy warehouse.

A world away, on Park Avenue, New York, Andrew Feldstein, co-founder and chief executive of BlueMountain Capital Management, sees in one of his favourite movies a lesson for Wall Street.

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“He’s about to walk away [from the ‘rap off’] – and then he has this brainstorm right before he goes on the stage. He goes out there and he raps it up, he basically exposes everything about himself, and then he turns to his competitor and says: ‘now what are you going to say?’”

This same strategy, Mr Feldstein argues, was used by Jamie Dimon, chief executive of JPMorgan Chase, when he volunteered details of failings in risk management that lost the bank more than $6bn last year betting on credit derivatives.

“Brilliant!” says Mr Feldstein. “It’s brilliant, right? ‘Here it is, guys. Now what are you going to say?’ And so actually I admire it as just good ethical principles. It’s great business strategy. It’s brilliant, I think.”

Mr Feldstein has a better vantage point than most into the “London whale”, a trader in the bank’s chief investment office that will be the subject of fresh scrutiny on Friday at a hearing of the US Senate’s main investigative panel.

BlueMountain took the other side of the trade and enjoyed profits when the market moved against the bank.

But more important to Mr Feldstein is what happened next. Stuck with a large lossmaking credit derivatives position, JPMorgan paid BlueMountain to unwind the trade.

This latter stage, co-operating with a bank to cleanse its balance sheet, is more interesting, Mr Feldstein says, than the initial opportunistic and adversarial trading, which together yielded an estimated $300m.

“It’s sort of a risk disposition in a transitional phase,” he says. “There is no evolved market for it yet.”

Outside the hedge fund, the idea that BlueMountain could play a big part in the evolution has gained ground after the JPMorgan deal.

“That trade really helped catapult them to a new level in many ways. It really made people take a look at them in a different light – as a problem solving institution, not just a trading shop,” says Henry Goodman, a banker at Credit Suisse.

Stephen Siderow, BlueMountain’s co-founder and president, says: “We can deliver value to our investors by putting their capital to work in those types of risk transfers.” For instance, last year the group took over a collection of derivatives from Crédit Agricole, the legacy of a now shuttered trading desk.

Mr Siderow says the fund is looking beyond such legacy deals to an active role taking on newly acquired risks that banks do not want to hold, and this year it hired Jes Staley, the JPMorgan executive who used to run the investment bank, to help it expand.

Similar trades done primarily to boost a bank’s regulatory capital – “reg cap” trades – are encountering scrutiny from regulators, including the Federal Reserve. But the case is also regulatory – higher capital charges and bans on proprietary trading that make warehousing assets less profitable or even illegal.

The hedge fund’s position alongside the bank points to the ambitious role the group hopes to play in financial markets as regulators force banks and other traditional lenders to withdraw from risky activities.

As banks retreat, mutual funds will hold a lot of debt from big corporations, says Mr Feldstein, but he predicts that the issuance from smaller companies, less liquid than the largest, will find a home with hedge funds such as his.

Meanwhile, there is still the bread and butter trading of a hedge fund. For instance, Mr Siderow, says that with high yield debt hard to value in absolute terms, relative to cyclical stocks it looks expensive. So the group has sold unsecured debt while buying stocks and high quality loans.

Attention to detail and the need to “institutionalise”, drawing from their backgrounds at JPMorgan, McKinsey and Goldman Sachs, is one hallmark. “They can be a pain in the butt,” says Talbot Stark, a senior relationship manager at BNP Paribas. “But it’s funds that don’t call me when something’s marked out by hundreds of thousands or a few million . . . If they don’t notice that they’re probably missing other things.”

The caution belies a desire to grow, and it has not gone unnoticed. “They are very aggressive about raising capital,” says one fund of fund manager with some clients who like the group and others are wary of a rush for scale.

And BlueMountain’s strong record of performance – a return of 14.4 per cent last year – also comes with a philosophical asterisk. During the crisis it restricted investor withdrawals when prices for the complex credit instruments it held were extremely depressed, an unpopular call vindicated in hindsight by the market recovery.

Mr Feldstein says part of the point of building an institution is to stop it chasing every opportunity. While he chooses Eminem as Mr Dimon’s avatar, for himself he goes more classical.

“It’s as much about restraining myself. It’s a bit like Ulysses. And you know the story, he sails his boat in between a rock and a hard place and he wants to hear the sirens singing so he tells his sailors to bind him to the mast so he can hear the song, but he’s not going to do something foolish and crash his ship.”

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