Management Firm: Metacapital Management
Strategy: Mortgage-backed arbitrage
Assets, in billions: $1.5
YTD total return: 37.8%
2011 return: 23.6%
(Reuters) – Deepak Narula, one of the hedge fund industry’s best known mortgage bond traders, said he sees a much tougher year ahead for investors but sees opportunities in certain mortgage trades.
Next year will “be a more challenging year” than 2013 because of “much greater uncertainty around how the Fed will behave,” and because of lofty bond and equity valuations, Narula, the founder of $1.45 billion hedge fund Metacapital Management, said on Wednesday.
This year Narula’s main fund has struggled to produce gains, though an investor recently told Reuters the portfolio has been able to reduce losses in the last few months. However, the firm’s $240 million Rising Rates fund, launched in May, has climbed about 14 percent year-to-date.
Last year, Metacapital’s flagship fund soared more than 40 percent, as structured credit funds rose about 19 percent on averaged. “Absent some large shock to the system” that causes initial cheapening of assets “those returns are history,” Narula said.
Those funds have only risen about 8 percent on average this year.
Managers who invested in residential mortgage-backed securities throughout 2012 and the beginning of 2013 benefited mightily from the Federal Reserve’s efforts to keep interest rates low, which pushed up the prices of mortgage bonds.
Deepak Narula has given us some sound advice – you want to be careful going against the mission of the Federal Reserve.
And, his hedge fund earned a 38 percent return last year, the number one hedge fund performer according to Bloomberg News.
“To revive the housing market, the Fed has thrown a lot of firepower at agency mortgage-backed securities. Policy makers have worked hard to let homeowners refinance. They’ve been clear that that’s their mission-and you want to be careful going against that mission.”
George Soros, who bet against the British pound in the 1990s and made millions of dollars, I’m sure, would agree.
In addition, three of the top five funds in the Bloomberg Markets list of top performing hedge funds also were investors in mortgage securities.
“Betting on mortgage securities outpaced every other strategy, with an average return of 20.2 percent against an industry average of just 1.3 percent,” states the Bloomberg report.
But, hedge funds are not the only ones that benefited from the Federal Reserve action. Check out these two posts: “Is it too late to get into the housing rebound?” and “Is it too late to get into the housing rebound? Part Two“.
Three cheers for saving the middle class!
Nothing seems to work better as a way to make money than to work with a government policy or program. Ask the people who started up Solyndra!
The major problem with betting against a government policy or program … don’t be too early.
Narula has not always been successful in playing the mortgage market. He started his fund Metacapital in 2002. He saw the danger in the market for subprime mortgages as early as 2005 and start shorting them. Subprime mortgages did tank, but not until three years later.
In 2006 his fund had to return money to investors and in 2007 he had to close the fund. He was “right,” but then again, he was “wrong.”
As he states, “If you are too early, you are wrong.”
But, betting “with” government policy works on the upside as well.
Over the past fifty years or so, the federal government, supported by the Federal Reserve, created credit by the millions of dollars in order to keep unemployment at low levels and to foster home ownership for the middle class and below. We had a sustained period of “credit inflation.”
Three things happen in a period of credit inflation: people take on more and more risk; people build up more and more financial leverage; and people engage in financial innovation. The last fifty years is known for all three of these things happening.
And, during this period, more and more people went to work in the financial and more and more companies added financial subsidiaries. By the early2000s, a substantially greater percentage of Americans worked in the financial sector than ever before. And, many manufacturing companies, likeGeneral Electric (GE) and General Motors (GM), earned more than fifty percent of their profits from their financial subsidiaries.
The “mission” of the federal government and the Federal Reserve System was to provide the economy with high levels of employment and greater degrees of home ownership.
The mental attitude of the leaders of American finance and industry? Well, as summarized by Charles (Chuck) Prince, the CEO of Citigroup, “”As long as the music is playing, you’ve got to get up and dance.”
Those that left the dance floor “too soon” were “right” that things were getting too risky and might fall apart. But, as Narula said, “If you are too early, you are wrong.”
Your government creates opportunities to make money … and to make lots of it. The big money to earn will, however, not go to those that will help to reduce the imbalance in the income/wealth curve. As we have seen, the past fifty years of credit inflation have done more to create the imbalances that now exist than reduce them.
And, government “missions” will continue to do so in the future.
So, one way to make money is to determine what is the federal government or the Federal Reserve “mission” and bet “with” the mission. That is, find out what these people are trying to do and develop an investment strategy that “uses” this mission. We know that the federal government and the Federal Reserve, in their well-meaning way, will continue on with their policies for a long time.
The Federal Reserve says that short-term interest rates will remain low until 2015. Really?
George Soros can tell you that when a government positions itself in this way, opportunities exist.
But, remember what Narula said – to be too early is to be wrong. Also, if you try and get into the game too late or stick around the game for too long, you will be wrong.
Timing is important.
Three cheers for Deepak Narula!
|State of Incorporation
|Annual Revenue Estimate
||6722, Management Investment Offices, Open-End
||525910, Open-End Investment Funds