Hedge Funds Exit Housing Securities as Prices Rise
Hedge funds that profited on residential mortgage debt after the financial crisis such as Pine River Capital Management and Canyon Partners are trimming their bets as prices rise.
Gorelick Brothers Capital is also exiting investments in both uninsured and governmentbacked home loan securities. The firm is seeking higher returns by raising a private equity fund to buy singlefamily rental houses, said Rael Gorelick, a cofounder of the firm.
Hedge funds that took a risk on distressed mortgage debt after the 2008 housing crash have had robust returns. Canyon Partners made $7 billion on nonagency securities in the decade before and after the financial crisis. Now these firms see dwindling opportunities as investors crowd into the market and issuance declines, pushing up prices of the nonagency debt.
“Spreads got tighter over the past few years,” said Colin Teichholtz, cohead of fixed income trading at Minnesotabased Pine River, which manages $15.5 billion. “It has gone from a great opportunity to a mediocre one.”
Returns at hedge funds that buy assetbacked securities, often including mortgage debt, averaged 10.2 percent last year, down from 13 percent in 2013, according to data compiled by Bloomberg.
Pine River cut its exposure to nonagency mortgagebacked securities, including subprime, from more than 40 percent in 2011 to below 10 percent today, Teichholtz said. The firm bought the debt at depressed prices after housing prices plummeted, and again in 2011 and 2012 when banks came under regulatory pressure to reduce their holdings.
“Even as that was happening, our mindset was that this cheapness couldn’t persist forever,” said Teichholtz, whose firm continues to invest in agency MBS.
Prices of nonagency debt have increased 176 percent from a low of $29 in April 2009, according to the ABX index. Some types of subprime mortgage securities offer projected yields of 5.8 percent, down by 0.5 percentage point from mid2014, according to Bank of America data. In the wake of the financial crisis, yields often exceeded 20 percent.
Pine River and other hedge funds are searching for higher yields in other markets, such as commercial mortgagebacked securities and collateralized loan obligations.
“Both those markets have a significant amount of new issuance,” said Manish Valecha, head of research at Gapstow Capital Partners, which invests in mortgage hedge funds.
Moody’s Investors Service expects new CMBS issuance to reach $110 billion this year, driven in part by 10year loans from 2005 coming due and strong deal activity. Issuance of CMBS could increase 40 percent to 50 percent this year compared with 2014, said Teichholtz.
Canyon Partners cut its holdings of nonagency securities to about $4 billion as of Dec. 31, down from $6.5 billion a year earlier, according to a marketing document obtained by Bloomberg News. The Los Angelesbased firm’s bet on the debt has produced a gross profit of 27 percent per year since 2005.
Investors at SkyBridge Capital and Gapstow Capital said they’re keeping their money in non agency MBS because the debt is still attractive compared to other types of securities.
“If you want to move out now, the question is where would you go?” said Troy Gayeski, the senior portfolio manager at New Yorkbased SkyBridge, which invests in hedge funds.
Junk bonds, which have more risk, are likely to make 2 percent to 5 percent this year, he said.
In 2013, SkyBridge started reducing its exposure to the securities because it saw more opportunities in eventdriven equity, which involves companies undergoing transformations such as spinoffs, mergers and acquisitions. Those returns have come down, which caused SkyBridge to start increasing its exposure to nonagency securities in the second quarter of last year.
Gayeski said he expects the mortgage securities that trade at a discount to par to produce a return of 6 percent to 10 percent this year.
Gapstow Capital, which invests in mortgage hedge funds, is also keeping its money in non agency MBS because the sector looks more attractive than high yield debt, where there is a lot of volatility, said Valecha.
Gorelick Brothers, which started two funds of hedge funds in 2008 and 2010 to take advantage of the steep decline in mortgagebacked securities, is redeeming its investments and handing the capital back to investors.
Gorelick said his North Carolinabased firm is searching for higher absolute returns by purchasing and renovating single family homes. He expects to receive steady income from rent payments, while eventually taking advantage of rising prices in the housing market by selling the homes.
There’s an undersupply of single family homes and apartments to rent for the first time since 2001, Frank Nothaft, chief economist at CoreLogic, said in December when held the same title at Freddie Mac.
The shortage is benefiting institutional investors who spent more than $25 billion since 2012 buying homes to rent. Rents on all single family homes and multifamily units are expected to climb 3.5 percent this year, compared with a 2.5 percent increase for home purchase prices, according to December estimates by Zillow Inc. Chief Economist Stan Humphries.
Gorelick said the opportunity in single family homes is similar to the environment for non agency bonds in 2010, when debt could be purchased with an implicit discount to collateral value.
“The value has moved from the debt to the equity,” he said. “Only inst
ead of a corporate balance sheet, we see this playing out in homes.”
Author By: Sabrina Willmer
Published In: FIN Alternatives