Mega Bets in $7 Trillion Market by BTG Upstage Macros: Mortgages
Louis Moore Bacon told investors it’s too hard to make money with macro hedge funds as government intervention and declining trading volumes limit the ability of managers to make large bets. He should consider the $7 trillion U.S. mortgage bond market.
Macro funds, which typically invest in bonds, currencies, commodities and stocks, have lost 1.9 percent this year, according to data compiled by Bloomberg. An exception: BTG Pactual Global Emerging Markets and Macro Fund, which has returned 16 percent, primarily from wagering on U.S. home loans and emerging-market rates, according to copies of client letters obtained by Bloomberg News.
The $3 billion fund has embraced central bank action, targeting government-backed agency mortgage debt that’s gained as the Federal Reserve has held interest rates near zero and signaled it may expand its holdings of the securities to bolster the economy. The fund has also bought non-agency debt that’s returned more than 20 percent this year, in some cases, as housing rebounds from a six-year slump and central bank policies push bond buyers to seek out higher returns.
“The Federal Reserve is the most important account in the world in terms of driving prices,” said David Martin, co-chief investment officer of BTG Pactual’s GEMM Fund. “Because people earn so little on their money, investors have been increasingly looking for ways to add yield. It just so happens that the mortgage market has a lot of products that fit our theme of investors’ search for yield.”
Macro funds, which typically don’t invest in mortgages, have underperformed this year as regulations prohibiting banks from trading for their own accounts reduced liquidity and government action made timing trades harder.
Ray Dalio, who runs Bridgewater Associates LP, lost 2 percent in his $54 billion macro fund through July 20, according to investors. Alan Howard, who runs Brevan Howard Asset Management LLP, has lost about 0.9 percent this year through Aug. 10 for investors in his Master Fund.
Bacon, whose fund has advanced more than 18 percent a year since starting the Moore Global Investments fund in 1989, said in a letter to clients earlier this month there are fewer opportunities and less liquidity in global markets. His main fund oversees $8 billion and the firm manages $15 billion.
Bacon returned a “disappointing” 0.35 percent in the first half and a “tolerable” 6 percent in the past year, he said in the letter.
The multibillion-dollar macro-fund manager plans to give back $2 billion, or 25 percent of his main hedge fund, to investors, saying it may be too big for him to achieve past returns as “liquidity and opportunities have become more constrained.” Shawn Pattison, a spokesman for Moore Capital Management LLC, declined to comment.
The biggest gain was from U.S. mortgages with government backing. Martin estimated there’s about $7 trillion of securitized debt, split between agency and non-agency RMBS. Trading totals about $100 trillion a year in the agency market, according to the Depository Trust & Clearing Corp., which runs a clearinghouse for that debt.
BTG Pactual purchased securities, such as Fannie Mae’s 3 percent bonds, which it expects the Fed will buy under a third round of quantitative easing. It’s also sought debt that benefits when the pace of homeowner refinancing remains constrained by banks’ unwillingness to lend and borrowers’ weakened finances.
“We’ve been very opportunistic there, primarily in agency mortgages around the potential of QE III being priced into the market and still lingering issues with people’s ability to re- finance in the U.S. because of tight credit conditions,” said Martin.
The Fed acquired $2.3 trillion of bonds in two rounds of quantitative easing from December 2008 to June 2011 to boost the economy. Many participants at the Fed’s meeting this week said a new large-scale asset-purchase program “could provide additional support for the economic recovery,” according to the minutes. QE III refers to what would be a third round of debt purchases.
In contrast to global macro, mortgage funds have risen 15 percent this year, according to data compiled by Bloomberg.
The Cerberus RMBS Opportunities Fund LP, with $1.2 billion in assets, gained 10 percent this year through July, according to a letter to investors dated Aug. 17 that was obtained by Bloomberg News. The residential mortgage-backed strategy is managed by Cerberus Capital Management LP’s Josh Weintraub.
Deepak Narula’s Metacapital Management LP posted gains of about 25 percent in its main, mortgage-focused hedge fund through July, according to a person familiar with the firm’s returns. The $1.2 billion vehicle invests in both agency and non-agency debt.
Betting on slow borrower refinancing in the agency market “continues to be the most attractively priced risk in the mortgage market,” Narula wrote last month in an investor letter.
BTG Pactual GEMM fund, which has 45 traders and eight strategies, from U.S. markets to foreign exchange trading and global equities, also made money this year on emerging-market rates, Martin said.
The fund profited from bets that Brazil would lower interest rates, he said, which paid off as the country cut its benchmark interest rate by 4.5 percentage points since August 2011 to a record low 8 percent in July.
Martin is also CIO of the $200 million BTG Pactual Distressed Mortgage Fund, which started in 2010 and focuses on U.S. residential mortgage securities that lack government backing. It’s risen 22 percent in the first seven months of 2012 after declining 4.7 percent in 2011.
“The notion that home prices in the U.S. have bottomed is growing and we believe as well that this isn’t a false bottom,” Martin said.
Sales of previously owned homes rose to an annual pace of 4.47 million last month, up from 4.37 million in June, the National Association of Realtors reported Aug. 22. Home prices have risen for three straight months since February after dropping more than 35 percent from the 2006 peak, according to an S&P/Case Shiller index.
Others profiting include D.E. Shaw & Co. and Canyon Partners LLC that have been lured to the $1.1 trillion market by property prices that are stabilizing after the biggest real- estate crash since the 1930s, projected yields that exceed corporate debt even with record defaults priced in, and expectations that Europe’s banks will sell to preserve capital.
Demand from rivals buying this kind of mortgage debt has made pricing a little less attractive, said Martin. “It was a heck of a lot easier to buy non-agency RMBS six months ago.”
Steve Jacobs, based in London, runs BTG Pactual’s money management business, in which it oversees hedge funds. BTG Pactual also has a wealth management division and investment bank categorized under the company’s broker-dealer arm. BTG Pactual’s chief executive officer is billionaire Andre Esteves.
In May 2006, UBS AG purchased Banco Pactual, which had been an independent Brazilian bank. Its main shareholders became UBS employees, including Esteves, who later left with roughly 15 others to found BTG in August 2008. In 2009, BTG agreed to buy Banco Pactual from UBS, forming BTG Pactual.