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John Devaney is quite possibly my hero. I’ll get to his $400m hedge fund, Horizon, later ($100m of it is his own money). When he was in college in the early 1990s, getting by on financial aid with no money in the bank, he bought one of those get-rich-quick videos, Buy a House With No Money Down!

“Do those actually work?” I asked him.

“Hell, yeah! I ordered the videos on my Citibank credit card that had a $350 limit and bought a house where I cleared $500 a month in cash flow.”

Starting from that, he became a partner in a bar that made $50,000 a summer for him for two summers, and then he opened a brokerage account and began trading options. By the time he left college he had $150,000 saved, owned a home, a boat, and several cars and motorcycles.

After graduating in 1994, John went to work for a broker who traded mortgage-backed securities. He turned that experience into setting up his own broker-dealer business in 1999. With less than $500,000 in starting capital he made $5m in 2000, $20m in 2001, $35m in 2002, and then $110m in 2003 trading junk bonds, mortgage-backed securities, and asset-backed securities.

“Every couple of years there’s a crisis that creates opportunity,” he told me when I asked him how he did it. “When LTCM blew up, everyone dumped the high loan-to-value BB-rated bonds that were all the rage then. Prices went from $95 to $50 even though the underlying collateral wasn’t any more or less risky.”

He told me this type of thing happened all the time. Another example was aircraft debt, which was downgraded after 9/11, forcing insurance companies to dump it en masse for regulatory reasons. “We were the buyer of last resort. Pooled leases on aircraft that we valued at 80 cents on the dollar we were buying for a lot cheaper just because the insurance companies were required to sell.”

On his analysis, there are 15 different sectors in the asset-backed market, of which about eight have suffered blow-ups in the last few years. “Whenever there’s a blow-up, there’s opportunity,” he told me. “Right now, it would be great for us if housing slides a bit and if the economy slides a bit. The small lenders will get in trouble and have to sell their loans cheap. Things always cycle and we are ready for the opportunities.”

When he set up his broker-dealer business he focused on getting clients on both the buy-side and the sell-side. Using the profits from his business he began booking all the entertainment for asset-backed lending conferences. He’s booked ZZ Top, Counting Crows, and other bands to play the conferences. “Everyone knew who I was. My firm, United Capital, was one of the top dealers for any asset-backed security.”

Not only did he begin trading his money more frequently in these securities, he began to trade and build up the net worths of family members, friends, and employees. “I’d buy a $20m bond and have to split it into 70 or 80 pieces for each account. So I set up a hedge fund in order to make it easier to trade for all these people. I’m putting about $10m a month of my own money into the fund and have about $106m in there right now. Many of my employees have all their net worth in the fund.”

He claims – and I believe him – to know everything going on in the asset-backed space. “If a security gets downgraded, we will understand what is going to come on the market six months out because of regulatory issues, when institutions are forced to sell. Then we get to work. We look at all the legal documents of the underlying assets, how they were set up, what the underlying collateral is, things like that.”

As he describes it, it is a common sense technique. He recently bought a collateral debt obligation containing franchise loans that were very distressed. About 40 per cent of the underlying loans were overdue and the bond had gone all the way from AAA down to CCC. But the part he bought had a senior lien on all the real estate. So at the start he and his team estimated that what they had bought was worth at least 60 cents on the dollar.

“We analyse all the current loans. What were the loan-to-values? What are all the current income statements on the franchises? What is the value of the underlying real estate? We value all the good loans, the loans that are still current, to anticipate how much more of the piece will become non-current. We then take each and every one of the bad loans, look at the foreclosure documents, we talk to the trustees of the bad loans. We work out how much money of the 40 cents we can get back.”

In this piece, he believed he could get back at least half of that 40 cents. “So we were about to buy for 60 cents on the dollar a security yielding almost 14 per cent that we think is worth about 85 cents.”

I looked up John’s fund, Horizon, on hedgefund.net. In 2005 he was up 49.7 per cent (and the fund just started in April of that year). So far this year, to the end of April, he is up 16.1 per cent.

“My mom has a net worth of $1.3m and she has $1.2m of that in the fund. So I definitely have an incentive to make money every month.”

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