As the market shakes and credits plummet, a few hedge funds are making profits by betting on a drop in the subprime index.
The credit market has not been easy for people So-called small lenders are bankrupt. Shares of big lenders like New Century Financial, NovaStar Financial, and Fremont General are plummeting as their customers default on their debts. But in the midst of all this, some hedge funds show big profits.
How is it possible ? These hedge funds showing large profits despite the collapse of the subprime market got away with betting on a fall in the ABX subprime index, which highlights the cost of insurance against default on the contracts of variable rate loans. This index, created by the Markit Group based in London, identifies 20 kinds of bonds at a relatively low rate. Last fall, some hedge funds began to slow the index, betting on a drop in it, as a way to limit the damage to their bond portfolio, or simply to anticipate a possible rout. of the sector. Betting on a fall in the ABX index paid off last February when the index crashed, posting a 34% year-on-year decline.
One of the crisis-resistant hedge funds is Paulson and Co., a $7 billion fund headed by John Paulson, formerly at Bern Stearn. Traders close to him say the hedge fund made a bet with huge leverage on the fall of the ABX index. The fund would have made a profit of several hundred million dollars when the ABX index collapsed, according to sources close to it. Paulson’s top adviser declined to comment.
THE SHOCK CONTINUES
Another hedge fund feasting on the carcasses of the subprime universe is MKP Capital Management, a $5 billion fund specializing in real estate securities. The fund, managed by Patrick McMahon and Maurice Perkins, has grown by 8% this year. People close to MKP say the fund’s executives literally poisoned the subprime sector earlier this year and put their bonds up for sale. MKP’s spokesperson declined to comment.
Indeed, the latest indications show that the number of hedge funds profiting from the subprime market crisis would be higher than that of bankrupt funds. Hedge Fund Research, based on the performance of hedge funds, presents a rise of 1.54% of its index in February. The annual increase amounts to 2.25%.
Of course, it is still too early and the repercussions of this crisis are still being felt. The damage will really hit hedge funds when the big credit agencies agree to downgrade real estate bonds, known as CDOs. There’s a lot of leeway when it comes to determining the value of a CDO in a hedge fund’s portfolio. Experts say a manager can put off writing a real estate asset until rates are lowered.
These discounts are close. At that time, the number of hedge funds showing profits could shrink.
