Canyon Trimming Bets on Mortgage Bonds After Making $7 Billion

Canyon Partners is paring its bullish investments in the mortgage-bond market after the hedge fund made about $7 billion in the past decade capitalizing on opportunities leading up to and following the financial crisis.

Canyon’s holdings of residential mortgage-backed securities fell to about $4 billion as of Dec. 31, down from $6.5 billion a year earlier, according to a marketing document obtained by Bloomberg News. The firm’s wagers on the debt have produced average annual gross profit of 27 percent since the Los Angeles-based hedge fund entered the market in 2005 with a bet against subprime loans that reaped about $900 million two years later.

While Canyon’s decision to trim the investments signals how some holders are no longer finding the debt as attractive after its rally in the wake the 2008 crisis, other buyers have stepped in, helping to extend the gains. Returns at hedge funds that buy asset-backed securities, often including mortgage debt, averaged

10.2 percent last year, down from 13 percent in 2013, according to data compiled by Bloomberg.

“We’re seeing more and more flows going from hedge funds and other investors seeking the really high returns to ‘real-money’ investors, like mutual funds and insurers,” said David Castillo, managing director in Los Angles at broker Odeon Capital Group. “It’s an inflection point.”

Canyon’s returns before fees and expenses on its mortgage-bond investments, which are overseen by Allen Ba and George Jikovski, accelerated to 27 percent in 2014 from 25 percent the prior year even as profits slowed for other RMBS investors.

Bill Launder, a spokesman for Canyon at Brunswick Group, declined to comment.

Subprime Wager

Canyon, like investors including Paulson & Co.’s John Paulson and LibreMax Capital’s Greg Lippmann, profited from betting against subprime before the crash. It also swooped in afterward to purchase bonds issued in 2006 and 2007 at distressed prices.

The firm later benefited as the Federal Reserve roiled the market with a “disorderly liquidation” of bonds acquired in its crisis-era rescue of American International Group Inc. in 2011, when Canyon bought most of its current holdings, according to the document.

The company, which manages $24 billion, is better known for investing in distressed corporate credits. It made a big gamble on RMBS in the years after the crisis, putting 32 percent of its flagship fund in the debt in 2011, its top allocation, according to an investor letter at the time.

That fund gained 4.4 percent in the first 11 months of last year, according to another letter, which said its managers had been “material net sellers” of RMBS while also buying some “mispriced securities.” The average hedge fund gained 3.6 percent last year, according to Hedge Fund Research Inc.

Rising Value

The average value of Canyon’s mortgage holdings rose to 61 cents on the dollar at the end of 2014 from 34 cents in 2011, the marketing document shows, as housing recovered and the most-troubled underlying borrowers lost homes or got debt reworked.

The share of borrowers with loans in Canyon’s securities who had equity in their properties more than doubled to 75 percent, while 42 percent had been current on payments for at least two years, up from 32 percent.

The market has also been bolstered by investors seeking higher yields while central banks across the world suppress borrowing costs, even as other risky debt such as high-yield corporate bonds has stumbled.

One type of speculative-grade subprime security that was originally rated AAA produced some of the best returns last year, typically gaining 13.3 percent, down from 38 percent in 2013, according to Bank of America Corp. data. Junk company bonds rose 2.5 percent in 2014, index data from the bank show.

Canyon’s subprime securities, which represented about 27 percent of its mortgage bonds, returned about 33 percent last year, up from 30 percent in 2013. Its holdings tied to Alt-A loans -- mortgages considered a step above the weakest subprime borrowers that backed the largest share of its investments -- gained 21 percent, down from 25 percent.

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