Weinstein Profits From Bond Distress as Paulson Loses

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The biggest swings in credit markets since 2008 are boosting demand for hedge funds that avoid bets on which way the economy is headed.

Saba Capital Management LP, started by former Deutsche Bank AG trader Boaz Weinstein in 2009, surpassed $1 billion in assets this month after gaining 1.6 percent in May, said an investor with the New York-based firm who declined to be identified because the information isn’t public.

Weinstein, a chess life master, is one of a growing number of hedge fund managers profiting from differences in prices between bonds, loans and derivatives as investors betting on sustained growth report losses. The rise in popularity of such long-short funds shows how the easy money has disappeared after junk bonds gained almost 70 percent in the 13 months through April. Gracie Credit Opportunities Fund LP and Claren Road Asset Management LLC, run by former Salomon Brothers traders, have about doubled their assets in the past year, people with knowledge of the firms said.

“Investors had an easy trade to do,” Weinstein, 37, said in an interview at the firm’s offices on the 58th floor of New York’s Chrysler Building, where the Art Deco eagle gargoyle that hovers above the firm’s balcony inspired the logo on Saba’s letterhead. “Now it’s done.”

Hedge Fund Losses

Hedge funds, or lightly regulated private pools of capital that allow managers to participate substantially in gains on the money invested, had their worst month since October 2008 in May as more investors questioned the strength of the economic recovery and the health of banks while nations in Europe grapple with rising debt. The European Central Bank said the region’s lenders will need to write off 195 billion euros ($233 billion) of bad debts by 2011.

The HFRX Global Hedge Fund Index lost 2.6 percent, as the MSCI World Index of stocks fell 9.9 percent and junk bonds as measured by Bank of America Merrill Lynch’s U.S. High Yield Master II Index declined 3.52 percent. The Standard & Poor’s/LSTA U.S. Leveraged Loan 100 Index tumbled 3.61 cents on the dollar, or 3.89 percent, to 89.11 cents.

John Paulson, 54, who oversees $35 billion in hedge funds and made $15 billion in 2007 betting against subprime mortgages, lost 4.2 percent in his Credit Opportunities fund last month, said a person familiar with the results. The fund is up 5.3 percent in 2010. His Advantage fund was down 4.9 percent through May, resulting in a year-to-date loss of 1.3 percent, the person said.

‘Opportunity Is Limited’

Paulson told investors last month he expects a V-shaped recovery in the U.S. and that Europe can manage its debt. Armel Leslie, a spokesman for Paulson, declined to comment.

“Many people will start to shift their exposure from long credit to more relative-value credit,” said Ermenio Schettino, a partner at London-based Falcon Money Management LLP, which manages $4 billion including money invested in long-short credit funds. “When you look at the price level of credit now, the opportunity is limited.”

Saba was up 5.8 percent through May, the investor in the fund said, compared with 3.39 percent for junk bonds and an increase of 2 percent in the S&P/LSTA loan index.

Weinstein ran an internal fund at Frankfurt-based Deutsche Bank before spinning off Saba, the Hebrew word for grandfather, in April 2009. The Deutsche Bank fund, which managed about $10 billion, lost about 18 percent in 2008, Weinstein’s only losing year out of 11 at the firm, a person with knowledge of the results told Bloomberg last year. The fund earned between $600 million and $700 million in 2007.

Claren, CQS

Claren, started in July 2005 by Brian Riano, John Eckerson and Sean Fahey, senior members of Salomon Brothers and then Citigroup Inc.’s global credit-trading department, has grown to about $3.7 billion from $1.8 billion in May 2009, said a person with direct knowledge of the firm’s assets.

A $120 million long-short credit fund managed by CQS U.K. LLP, the London-based manager with $6.9 billion in assets, gained 1.35 percent in May and is up 8 percent this year, said an investor in the fund.

Suzanne Murphy, head of strategic development at Claren, and a spokesman for CQS declined to comment.

“The rally was so short, and now we’re back to this very unsteady foundation again,” said James Palmisciano, chief investment officer at New York-based Gracie, which returned 17.9 percent in 2008 amid the financial crisis and 16.2 percent last year. “You need to be a lot more nimble as opposed to just believing that we’re back into a pro-cyclical investment environment.”

Price Swings

Gracie gained 3.6 percent this year through May, and has almost doubled its assets over the past 12 months to $1.7 billion, said an investor familiar with the fund. Palmisciano and Gracie partners Michael Robertson, Manbir Singh and Alex Koundourakis joined the fund in 2005 from Calyon’s proprietary trading desk. Palmisciano worked for Weinstein as a lead analyst before leaving for Calyon in 2003.

Almost every hedge fund strategy lost money in May, according to Hedge Fund Research Inc. in Chicago. Hedge funds that buy distressed corporate debt dropped 2.76 percent on average last month, according to the HFRI Distressed/Restructuring Index. The index is up 4.28 percent in 2010.

Credit markets are experiencing the biggest price swings since October 2008, as measured by realized volatility of the Markit CDX North America Investment-Grade Index, a credit derivatives index that is a benchmark indicator for perceived risk in the corporate bond market. The index’s volatility for the previous 30 trading days climbed to 113.5 on June 4, up from 33.9 on April 1, data compiled by Bloomberg show.

‘Huge Opportunities’

“We wouldn’t advocate right now any sort of market directional position,” Andrew Feldstein, BlueMountain Capital Management LLC’s chief executive officer, said last month at the Bloomberg Markets Hedge Fund Summit in New York. “There are huge opportunities -- massive opportunities -- totally independent of market direction.”

BlueMountain, whose founders helped pioneer credit-default swaps in the 1990s and which oversees about $4 billion from New York, said in April it raised more than $250 million, including for a long-short credit fund.

Sancus Capital Management, manager of a long-short fund with about $80 million and started in August by former JPMorgan Chase & Co. proprietary traders Olga Chernova, Svetlin Petkov and Jason Chen, made 4.9 percent this year through April and was up 0.02 percent in May, another investor said.

Long-Short Fund

Highland Capital Management LP, the $24.1 billion investment firm specializing in leveraged loans, plans to start a long-short fund that will seek to capitalize on price swings, according to Mark Okada, chief investment officer of the Dallas- based firm. Investors are willing to give up some potential gains to hedge the risk of a downturn, he said.

“We had this major reflation of risk assets across the board,” said Okada. “We’re kind of coming to an end of that trade. Markets are now trading in range and I think that’s where we’re going to be in the foreseeable future.”

The expanding pessimism follows unprecedented government intervention to unlock debt markets. The cash pumped into the financial system by central banks and through government spending gave banks the confidence to lend to each other.

The London interbank offered rate for dollars declined to 0.25 percent in December from 4.82 percent in October 2008, one month after Lehman Brothers Holdings Inc. filed for bankruptcy. Corporate bond yields fell to within 1.42 percentage points of Treasuries in April from 5.11 in March 2009. Prices of high-yield, or leveraged, loans soared to 92.9 cents on the dollar two months ago from a record low 59.2 cents in December 2008.

Fresh Optimism

Last month’s sell-off has sparked optimism that the rally will resume after corporate profits jumped 31 percent last quarter from a year earlier. Earnings have surged as fast only six times in the past 60 years, according to Barclays Capital. Each of those periods was followed by gross domestic product growth of at least 3 percent the following year.

“Fears of a broader European bank funding crisis appear overblown,” fixed-income strategists led by Srini Ramaswamy at New York-based JPMorgan said in a report dated June 4. “While volatility may remain high over the near term, robust U.S. economic fundamentals will likely emerge as the more important driver of risky assets over the medium term.”

Profits During Distress

While underscoring investors’ concerns about the strength of the U.S. recovery and Europe’s sovereign debt crisis, the trend toward long-short funds also shows how traders who developed the market for credit-default swaps continue to profit even when markets are in distress. Swaps are derivatives, or contracts whose value is tied to assets including stocks, bonds, commodities and currencies, or events such as changes in interest rates or the weather.

Weinstein’s Saba bought ArvinMeritor Inc. bonds due in 2012 at 102 cents on the dollar while simultaneously buying credit-default swaps that hedged against losses on the auto-parts maker’s debt, according to a letter sent to investors in March. The trade returned 7 percent after the Troy, Michigan-based company offered to repurchase its debt in February for 109.75 cents on the dollar, the letter said.

BlueMountain gained in April by purchasing enhanced equipment trust certificates, bonds sold by airline carriers to finance planes, and hedging them with credit-default swaps.

The strategy, known as a basis trade, profits when there is a larger-than-usual gap between the price of the two instruments. The investments are designed to gain in value even if markets decline.

New Firms

Many long-short credit managers started on proprietary trading desks of Wall Street’s largest banks. As Wall Street reduces proprietary bets, new firms are forming, increasing the managers focused on the strategy.

While companies sell bonds to refinance loans, “banks’ balance sheets haven’t expanded,” said Simon Finch, chief investment officer credit at CQS and senior portfolio manager for the CQS Credit Long Short Fund. “It’s likely to continue to place the market under pressure as that change occurs. That will lead to heightened volatility as these larger flows are digested.”


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