BlueMountain Capital Management LLC, the $15.7 billion credit and equity derivatives hedge-fund firm founded by Andrew Feldstein and Stephen Siderow, said investments in residential mortgage debt have among the best growth prospects.
“In liquid structured credit, we expect RMBS to be the biggest growth area for us,” Feldstein, chief executive officer and chief investment officer at BlueMountain, wrote in the letter to investors, a copy of which was obtained by Bloomberg News, referring to residential mortgage-backed securities.
BlueMountain is seeing opportunities to profit in the mortgage market as President Barack Obama has called for an overhaul of housing finance and government-sponsored enterprises such as Fannie Mae and Freddie Mac. A housing bill that has support from Republicans and Democrats would replace Fannie Mae and Freddie Mac with a federal reinsurer that would step in only after private capital had taken at least 10 percent of the first losses on mortgage securities.
“The market is in flux given the creative destruction levied by the financial crisis; and the future of the GSE’s is, of course, entirely uncertain,” Feldstein wrote, using the acronym for government-sponsored enterprises.
BlueMountain, which last year helped JPMorgan Chase & Co. unwind trades that led to a loss of more than $6.2 billion at the bank, posted returns in its various funds in the first half of the year of 4.4 percent to 7 percent, according to the letter. The firm has about 85 percent of its capital in relative-value strategies, with the remainder in longer-duration pools.
BlueMountain was founded by Feldstein, a former JPMorgan executive who helped create the credit-default swaps market, and Siderow in 2003.
Doug Hesney, a spokesman for BlueMountain with Dukas Public Relations Inc., declined to comment on the letter.
BlueMountain specializes in spotting abnormalities in price relationships in credit swaps. The firm exploits small, intermittent differences in price, such as those among bonds and the swaps that insure them, and uses custom algorithms to arbitrage swaps and the indexes that London-based Markit Group Ltd. owns and manages.
The development of rules under the Dodd-Frank Act for the trading and clearing of the about $600 trillion annual market in financial swaps, some of which were at the center of the 2007 to 2008 financial crisis, may create more opportunities for exploiting pricing differences between indexes and credit default swaps tied to single securities, BlueMountain said in the letter. Credit default swaps, or CDS, are contracts that pay the buyer face value if a borrower fails to meet its obligations, minus the value of the defaulted debt, tools for investors to hedge risk. An increase in the swaps indicates that derivatives traders view the company as more risky.
“Once clearinghouse rules are set, the opportunity may increase, as the number of index market participants continues to grow, while participants in single-name CDS may not,” Feldstein wrote in the letter. “This imbalance in market participants could lead to more frequent differences between the price of an index and the price of its constituents, creating arbitrage opportunities.”
BlueMountain started two new collateralized-loan obligations in the first half of the year, bringing such assets to about $3 billion, according to the letter. CLOs are a type of collateralized debt obligation that pool high-yield, high-risk loans and slice them into securities of varying risk and return.
BlueMountain plans to open a Tokyo office before the end of the year, according to the letter.
“We’re excited to extend our global reach and believe that having feet on the ground in the world’s third-largest economy will enable us to continue to generate alpha in new and diversified strategies, including but not limited to fundamental investing and equity derivatives,” Feldstein wrote in the letter.
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