Hedge funds expect more alpha in mortgage trades

Hedge fund managers specialising in US residential mortgage strategies urged investors to stick with the asset class, dismissing concerns that returns are bound to taper off after big gains in recent years.

“The opportunity in mortgage credit markets is as good if not better than it was two years ago,” says Josh Birnbaum, chief investment officer of Tilden Park Capital Management, speaking at the Salt conference in Las Vegas. The company’s main fund returned over 40% last year.

Birnbaum, a former Goldman Sachs trader, says advances in the way mortgage securities are analysed and priced have made it easier for hedge funds to earn higher returns through security selection. “The macro trade [of purchasing discounted mortgage securities] is not as good as it was but there are as many micro opportunities than there were two years ago,” he says.

Research conducted by Tilden Park shows the dispersion of single names within the mortgage sector is at least as good as in the equity markets. This means hedge funds can generate alpha by going long and short individual bonds, Birnbaum says.

Others argue hedge funds will have a bigger role to play in the mortgage sector as banks, insurance companies and government agencies retreat from the sector.

Phillip Weingord, founder and CEO of Seer Capital Management, says hedge funds are the natural buyers of subordinated tranches of mortgage securities, which were previously held on bank balance sheets.

Hedge fund managers estimate the amount of bank capital dedicated to mortgage trading is down around 70% from its pre-crisis peak.

“The banks and insurance companies are not going to be the same risk providers, which is going to leave a vacuum for private capital,” says Birnbaum.

Tilden Park recently hired Keeyeol Nam, a former head of structured products proprietary trading at Deutsche Bank, to lead a team that will trade agency mortgage securities, Birnbaum says.

Anilesh Ahuja, CEO and chief investment officer of Premium Point Investments, cites home price appreciation and an uptick in mortgage origination as reasons for optimism.

As banks are only offering home loans to the safest prime borrowers with pristine credit histories, some of the newly minted mortgage securities are pretty attractive, he says. 

Ahuja reckons investors can earn total returns of around 20% with limited risk if they buy into the bottom of the capital structure of some of these newly created mortgage securities.

Birnbaum, Weingord and Ahuja were speaking on a panel on mortgage strategies at the Salt conference in Las Vegas.

 

This article was first published on Risk

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