Unstructured Finance

Natural (at) selection

March 21, 2013

The answer to the moderator’s question was a resounding: yes. The question, asked to several credit hedge fund managers during a conference on Thursday, was: did you make money last year? In fact, the managers from Pine River, BlueMountain, Cerberus and Brevan Howard made a lot. But 2013 is not going to be so easy, they said.

Hedge funds that specialize in credit, especially those who focus on mortgage-backed securities (MBS), blasted past their stock market competitors in 2012. One of those traders, Steve Kuhn, was on stage for the aforementioned credit panel at Absolute Return’s Spring Symposium. Kuhn, a portfolio manager for Pine River Capital Management, saw his fixed income fund rise 35 percent last year.

Kuhn doesn’t see a repeat of those monster returns in 2013. It’s all about security selection this year, he said and that that selection process is going to require a lot of work. It’s a view we reported in early March, and one that Scott Stelzer, a CMBS specialist for Cerberus Capital Management and David Warren, the CEO of DW Investment Management and CIO for a Brevan Howard credit fund also echoed at the conference in mid-town Manhattan.

So, where are these managers allocating capital this year? At the moment, Steve Kuhn likes convertible bonds in Asia. He said there’s still some alpha in the RMBS market, but the beta trade is now a now 6/10, whereas it was 10/10 a year ago. He’s also excited about opportunities to invest in new issuance as Fannie and Freddie begin to reduce their 95 percent mortgage-market footprint.

Cerberus’ Stelzer, who still likes the CMBS trade, emphasized that last year’s desperate yield search had seen a ton of players move into those securities where they probably should have stayed away. This style-drift has occurred as hedge fund managers moved outside of their specialties, desperate to boost returns in the a low-interest rate environment. We reported, for example, on the move into CLOs and CDOs in the second half of last year.

“People are getting into areas they don’t understand,” Stelzer said, adding that to bet on CMBS, “you need to know the underlying loans.” Stelzer said even traders that specialize in residential MBS don’t necessarily have the right expertise to do CMBS selection. (Boaz Weinstein, who appeared at the symposium later in the day, said he is also bullish on CMBS right now. MBS specialists like Greg Lippmann of LibreMax turned to CMBS last year, as did Jeff Kronthal’s KLS Diversified Asset Management and bond firm DoubleLine.)

As for the so-called Great Rotation into stocks and out of bonds – the name of the panel was, in fact, How do you plan for the bond unwind? – Brevan Howard’s David Warren rejected that the rotation had begun, as guests on a previous panel had suggested. “The Great Rotation is not happening,” said Warren. “It’s a myth.”

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