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News : International Last Updated: Apr 24, 2009 - 5:31:05 PM


Hedge fund made 1,000% return on subprime bet in 2007 as most market players expected the problem to be contained
By Finfacts Team
Nov 26, 2007 - 8:56:00 AM

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Proving that an ill wind blows somebody good, it has been reported that a Californian hedge fund has made more than 1,000% return this year by betting against US subprime home loans, making it one of the world�s best-performing funds of all time.

On the day in February 2007 that global bank HSBC triggered the news of the US subprime home lending crisis by reporting huge losses on its loans to people with dodgy credit records, Andrew Lahde was launching hedge funds to reap the benefits of what he expected to be a serious crisis while the large majority in the finance sector convinced themselves without much thought, that the problem would be contained as it related to a sector of the home loan market that was not significant overall.

Federal Reserve Chairman Ben Bernanke and former Master of the Universe at Goldman Sachs, US Treasury Secretary Hank Paulson, led the chorus on containment.

Lahde Capital last week passed the 1,000% mark, after fees as the plunge in the value of subprime-linked securities has boosted its funds

FinAlternatives reported  last February, that a California firm had launched a trio of hedge funds poised to cash in on the burst of the real-estate bubble.

Lahde Capital, based in Santa Monica, unveiled US Residential Real Estate Hedge I, II and V. All three funds utilize the same strategy�shorting the riskiest tranches of subprime mortgage securitizations�but with differing levels of leverage, topping out at five times leverage.

"The conditions that led to the mass proliferation of sub-prime mortgage underwriting have all reversed," founder Andrew Lahde explained. "We are now in an environment where it is virtually impossible to profitably underwrite subprime mortgages."

Increased delinquencies and foreclosures were expected to negatively impact the lowest-rated tranches of mortgage-backed securities. "The riskiest pieces of these securitizations can be wiped out entirely in a situation that is even moderately different from the goldilocks environment we have lived in for the past six years," Lahde said.

The funds charged a 1% management and 20% performance fee, with a $250,000 minimum investment requirement.

The Financial Times says that the decision to use derivatives to short, or bet against, low-quality US home loans taken by a select group of hedge funds last year appears to have become the most profitable single trade of all time, making well over $20bn in total so far this year. John Paulson's New York-based Paulson & Co, the biggest of the group with $28bn under management, is said by investors to have made $12bn profit from the trade already.

Lahde has begun to return money to investors, telling them in a letter: "The risk/return characteristics are far less attractive than in the past."

In his letter, Andrew Lahde said he expected the collapse in value of subprime mortgage-linked securities to be repeated for bonds backed by commercial property loans in a deep recession - which he also forecasts.

"Our entire banking system is a complete disaster," he wrote. "In my opinion, nearly every major bank would be insolvent if they marked their assets to market." He also said he would be investing some of his own profits into gold and other precious metals.

Lahde has now launched a fund to bet against commercial real estate this autumn � which made 42% in its first two months � and is in the process of creating a third fund to short credits with a broader mandate.

Lahde's first fund, US Residential Real Estate Hedge V Class A, had risen 712.8% in the year to the end of October, before this month�s sell-off pushed it past the 1,000% mark.

The FT says that there is no reliable data on how many other funds have made 1,000 per cent, or ten times the investment, in a year. But RAB Capital, London hedge fund manager, shot to prominence in 2003 when it returned 1,475.5 per cent in its Special Situations fund, which now runs $2.4bn and is the biggest shareholder in troubled bank Northern Rock.

Bigger subprime top performers include Paulson's Credit Opportunities fund, up 550.8 per cent to the end of October, and the Subprime Credit Strategies fund run jointly by Texas-based Hayman Capital and Corriente Advisors, up 526.5 per cent.

 

Andrew Lahde commented in a note to investors last summer:

Rising tides lift all boats. Rock, paper, scissors. Tsunami crushes all (except those who bought tsunami insurance and got the hell away from the water). The tsunami is this credit contraction I have been writing about for the past year. It has affected everything. Period.

Fellow CFAs probably remember learning about the mosaic theory, which distinguishes between plain old inside information and attaining information from different sources and combining them together to reach a conclusion that is virtually as good as ill-gotten inside information. I have so many sources of information, both the factual/statistical type and the anecdotal type. Everything I see tells me the ABX is going to fall further, as is the CMBX, the equity market, the dollar, etc,

If God comes down and miraculously fixes everything that is going to drive us into a deep recession, we probably still would not lose money on the CMBX trades.

There isn't enough lipstick in the world to sell a pool of subprime loans right now.

Will Bush help? No. His plan would help some 80,000 borrowers out of the two million subprime borrowers whose mortgage payments jump in the next two years. Try again.

Good night and good luck. 

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