Pine River Picks REIT Winners in Renewed Housing Bets
Pine River Capital Management LP, whose bets on U.S. home-loan bonds fueled the second-best hedge fund performance of last year, is picking winners and losers among the publicly traded companies that invest in the debt.
The firm bought shares of mortgage real-estate investment trusts, including two run by ex-Freddie Mac portfolio chief Gary Kain, while wagering against others amid the industry’s worst quarterly slump since 2007, said Steve Kuhn, its fixed-income trading head. Pine River, which disclosed this month it quintupled its stake to 9.2 percent in Kain’s American Capital Mortgage Investment Corp. (MTGE), is investing based on its view of the skills of the managers and the value of their assets, he said.
Pine River is increasing its REIT investments as the $13.6 billion firm also renews bets on mortgage bonds following a slump sparked by the Federal Reserve’s comments on potential stimulus reduction. The Minnetonka, Minnesota-based firm views home-loan bonds without government backing as cheap relative to corporate securities -- after earlier this year cutting holdings in its largest fund to less than half the share in 2011.
“It’s the first time I can say that in a long time,” said Colin Teichholtz, a senior portfolio manager focused on fixed income. “The sector was getting better fundamentally, but the pricing was just less interesting to us. Now, it’s not as compelling as the once-in-a-lifetime opportunity we saw in 2011 but it’s still attractive.”
Subprime-mortgage securities and other debt known as non-agency bonds fueled a 35 percent return last year for the $3.6 billion Pine River Fixed Income Fund managed by Kuhn.
The fund has gained 6.6 percent this year, even after a 1.4 percent loss last month as the Fed roiled credit markets with signals it may reduce stimulus efforts, according to an investor with knowledge of the matter, who asked not to be identified because the information is private. Its $2.6 billion multi-strategy fund, which can invest in the debt fund and is run by Aaron Yeary and James Clark, lost 2 percent in June to trim gains to 6.9 percent this year.
Kuhn and Teichholtz declined to comment on the performance.
SkyBridge Capital, which invests $5 billion in hedge funds for clients, had been reducing its allocations to mortgage managers, according to Troy Gayeski, a senior portfolio manager. Investments in vehicles focused on government-backed securities fell to 25 percent, from 40 percent in December and non-agency strategies dropped to 28 percent from 36 percent in March.
The New York-based firm has since reversed that trend.
Gayeski said he thinks non-agency debt is attractive because its recovery this month has trailed other risky assets such as equities, even with housing improving and defaults falling. Bonds whose returns are tied to how fast homeowners repay government-backed loans potentially may do even better in the next few months after a “shellacking” in April and May, he said.
“Looking at the overall opportunity set, we think it’s been completely refreshed,” said Gayeski, whose company has disclosed investments in Pine River’s funds.
Pine River has focused on mortgage REITs, which use borrowed money to invest in home-loan debt, amid a rout in the shares. The shares fell as the falling values of their holdings, amplified by leverage, prompted investors to sell.
A Bloomberg index of the companies declined 17 percent, including reinvested dividends, since April, with American Capital Mortgage dropping 26 percent.
Two Harbors Investment Corp. (TWO), a mortgage REIT overseen by Pine River and run by separate employees to the hedge fund, has lost 13.5 percent. Pine River, which also runs Silver Bay Realty Trust Corp., a single-family home rental company, doesn’t invest in its own REITs.
Kain’s American Capital Agency Corp. (AGNC), which Pine River also owns shares in, has fallen 30.4 percent. The firm, which only invests in government-backed securities, is less attractive than American Capital Mortgage, a REIT that also buys non-agency bonds, Teichholtz said.
He declined to comment on other individual REITs, including those it’s betting against. While it likes Kain’s firms partly because he’s “a great manager,” it also tries to targets REITs trading at larger discounts to its estimates of their current book value, Teichholtz said.
“To buy into pools of those bonds at 80 to 90 cents on the dollar, we think that’s pretty attractive,” according to Teichholtz, who said Pine River is also putting on hedges against rising interest rates as part of the strategy.
Richard Eckert, an MLV & Co. analyst, sees many of the firms as good bets because they can earn higher yields on newly purchased bonds while the Fed continues to hold the cost of their short-term borrowing near zero and their shares trade below the net value of their assets.
Investors need to be careful because some may be taking too much risk with their leverage and liquidity, meaning they may fail to navigate any further bond volatility, he said.
“There still are some cowboys out there,” said Eckert, who declined to talk about specific companies as he prepared to publish research on the sector.
Brian Taylor, who spent 14 years at hedge fund EBF & Associates, founded Pine River in 2002, naming it after a Minnesota town close to where he has a lake house.
The company decided to focus on mortgage investing after the dislocations created by the 2008 financial crisis and resulting changes driven partly by regulators and Wall Street risk managers. Banks scaled back trading desks and government-chartered Fannie Mae and Freddie Mac reduced their investment portfolios, Kuhn and Teichholtz said.
In 2012, Pine River’s fixed-income fund ranked No. 2 in a Bloomberg Markets magazine’s list of top-performing hedge funds overseeing at least $1 billion, as mortgage managers including Metacapital Management LP and Seer Capital Management LP outperformed all other strategies. Mortgage bets also helped the fund rank No. 7 in the magazine’s 2010 list.
Pine River’s hedge funds earlier this year increased exposure to equities, including financial companies, and corporate bonds. In the past year, the firm also built an energy-related equities team of six based in Pine River’s Austin office, which opened in February to attract investment talent and clients.
Like in 2011, when a rally in mortgage bonds was disrupted by Europe’s debt crisis, the market has recently become more challenging as Fed officials signal they may slow their $85 billion in monthly bond buying as the economy shows signs of strengthening.
Former Deutsche Bank AG banker Neil Ahuja’s Premium Point Investments LP saw its mortgage credit fund lose an estimated 3.4 percent last month, to leave it up 5.9 percent this year, according to people familiar with its return.
The credit fund run by MKP Capital Management LLC, which oversees $7.3 billion, fell 4.6 percent, to trim its gains to 5 percent. Don Brownstein’s Structured Portfolio Management LLC’s SPM Core fund fell an estimated 2.5 percent to expand 2013 losses to 8.4 percent.
Spokesmen for the companies declined to comment.
While various types of government-backed mortgage bonds have cheapened, the opportunity isn’t as attractive as non-agency debt, according to Teichholtz.
Interest-only and inverse interest-only securities, debt that loses value when homeowners refinance, has recovered after a rout sparked by concern about potential government policy changes.
“That’s the one market that actually got bailed out when interest rates sold off so hard,” he said. “We still think there’s value there, but not as much as we were hoping for.”