October 9, 2012 3:57 pm

Hedge funds reap gains from MBS

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Hedge funds are reaping some of their biggest profits from the securitised mortgage market since 2007, when mispricings in complex debt securities led to huge windfalls for savvy traders such as John Paulson and the near-collapse of the global banking system.

While the average hedge fund has made just 4.6 per cent so far this year, funds dabbling in US mortgage-backed bond markets have reaped far bigger gains, in some cases running into the hundreds of millions of dollars, investors say.

Tilden Park, a $1bn hedge fund run by Goldman Sachs’ former mortgage-backed securities team, was up 30 per cent as at the end of September, according to a client of the firm.

A $1bn mortgage-focused hedge fund at Pine River, run by another Goldman alumnus, Steve Kuhn, was up over 24 per cent for the year to the end of September. Pine River’s $3.5bn flagship fixed income fund, which made similar bets in mortgages, was up nearly 29 per cent in the same period.

Obsidian, one of the flagship fixed income hedge funds run by asset management giant BlackRock, was up 25 per cent at the end of August, according to a client of the company.

Hedge funds run by BTG Pactual, the Brazilian investment bank, have also surged thanks to bets in US MBS. The BTG Pactual Distressed Mortgage fund was up 28 per cent for the year to August 31.

Other top-name funds that have benefited from the mortgage markets include CQS’ $2.2bn asset-backed securities fund, run by Alistair Lumsden, up 13 per cent to the end of September, and Brevan Howard’s $3bn Credit Catalysts fund, up 10.4 per cent.

Improving fundamentals for the US housing market and large liquidity support from the US Federal Reserve have triggered a major rally in mortgage securities this year that hedge funds have been quick to take advantage of.

Even non-specialist managers have made big gains. Asset-backed bonds have been among the best performing investments for Third Point, the $9bn hedge fund run by outspoken manager Dan Loeb.

Mortgage-backed securities had been identified by investors as “the hottest area for credit investing”, Mr Loeb said in his most recent letter to clients on October 3.

Third Point has more than $1.3bn invested in MBS. Subprime mortgages in particular have been among those that have performed best for the firm, returning, on average, 24.3 per cent so far this year.

Mr Loeb warned that capital inflows into the mortgage markets were “effusive”, however, which was also creating attractive shorting opportunities.

“We expect overall asset-backed exposure will remain at these levels or grow in our portfolio for the balance of 2012, and are looking forward to increasing opportunities in the CMBS space in 2013 and beyond,” the letter added.

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