| From subprime wreckage, hedge fund winners and losers |
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| 05/08/2007 | |
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You first read it here. In December 2006 bfinance wrote about the growing danger of owning speculative-grade debt in an article titled "Heady days coming to an end for high yield" (12/27/06). "High yield spreads could widen 50 basis points in 2007 at the first sign of a corporate failing or mini-fund blow up." Six months later in June, bfinance underscored the growing role of hedge funds in the CDO market. The high-yield landscape, of course, is wide and varied, and not all hedge funds have been on the losing side of the current turmoil. First, the bad news. Since June, a raft of hedge funds have collapsed on credit market woes. Risk spreads between US Treasuries and high yield debt have widened from a level of 330bps to around 450bps. As prices declined, losses forced Bear Stearns to close two of its hedge funds. Sowood Capital Management's Alpha Fund lost 57% in July, according to a letter sent to clients. The $10.3bn Tudor BVI Fund, a hedge fund run by Paul Tudor Jones lost 3% through July 27 and on August 1 a third hedge fund operated by Bear Stearns, with $900m of mortgage-related investments, informed its clients that they would not be able to withdraw funds. While the blowups may not be linked, a number of market strategists contend that CDOs and riskier subprime loans are coming home to roost. One concern is the month-end performance of hedge funds when managers mark to market their holdings and report their performance to their counterparty lenders and brokers. If they have suffered losses, the brokers can request additional collateral, which is what happened in the case of Bear Stearns. Short subprime Amid the carnage a number of winners have emerged, in particular hedge funds that have been on the short side of subprime mortgages. The ABX index, which tracks the performance of various classes of subprime-related bonds, has dropped from $90 in January to the high $30 range, according to Infovest21. As a result, hedge funds betting on subprime-related bonds falling posted hefty returns in the past two months. A $2bn fund run by Paulson & Co. returned 39.5% after fees in June following a series of bets against subprime mortgages. The $500m Texas hedge fund, Hayman Capital and Balestra Capital have also realised significant gains. A number of these funds, Balestra in particular, turned negative on US mortgage and subprime loans in 2006 when fixed-income spreads were particularly tight. "Low policy rates in many countries and narrow credit spreads have encouraged levered structures bought in the hundreds of millions by lenders, in an effort to maximise returns with what they thought were relatively risk-less loans," says Bill Gross, Managing director at PIMCO. "Those were the ABS, CDOs, CLOs, and levered CDO structures that the rating services assigned investment grade ratings, which then were sold with the enticing LIBOR+ 100, 200, 300 or more type of yields. The bloom came off the rose and the worm started to turn, however, when institutional investors – many of them foreign – began to see the ratings downgrades in the ABS subprime space." "Could the same thing happen to levered structures with pure corporate credit banking?" asks Gross. "How can the market have confidence that (the rating agencies) are not repeating the same structural, formulaic mistake with CLOs and CDOs? That growing lack of confidence, more than the default of two Bear Stearns hedge funds, and the threat of more to come, has frozen future lending and backed up the market of high yield new issues such that it resembles a constipated owl: absolutely nothing is moving." VB |
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