Money managers are finding a bevy of opportunities in the subprime-mortgage fallout.
NEW YORK — Money managers are finding a bevy of opportunities in the subprime-mortgage fallout.
Some are starting new funds to buy distressed securities tied to the subprime market. Others see opportunity in asset-backed securities that are not directly tied to the subprime market but have been devalued because of a lack of confidence in the rating agencies that assign value to them.
Marathon Asset Management LLC of New York introduced a new hedge fund, the Marathon Distressed Subprime Fund, to “capitalize from the fallout and carnage in the subprime-mortgage market with a core investment strategy to opportunistically purchase distressed mortgage related and subprime assets,” according to a letter to investors obtained by sister publication Pensions & Investments.
“The meltdown in the subprime-mortgage market has been absolutely stunning and, given this significant opportunity, Marathon has decided to roll out this fund,’’ the letter said.
Marathon was to begin taking commitments for the fund this month, and the investment period will last only two years, the letter said. Marathon executives declined to comment.
Black Pearl Asset Management LLC of Walnut Creek, Calif., has created a separate-accounts strategy designed to take advantage of short-term opportunities in the asset-backed-securities market. Sources said the firm is also launching a hedge fund, though chief investment officer James Midanek declined to discuss it.
Lower lows to come
“We haven’t seen the lows in valuations [of asset-backed securities], or even close. You’re just starting to see a dislocation as investors come to the realization that the valuations of asset-backed securities are lower than they thought,” he said, speaking of the strategy.
“Buyers of these securities didn’t always understand the inherent risk, and they’re likely to sell,” Mr. Midanek added.
As defaults and delinquencies on subprime mortgage loans continue to rise, the valuation of asset-backed securities will continue to decline. The peak time to buy asset-backed securities will come in three to six months, Mr. Midanek said. “It’s important for investors who want to take advantage to be ready,” he said.
Mr. Midanek predicted that defaults will wipe out the lower-quality tranches of asset-backed securities. As a result, the higher-rated tranches will suffer ratings declines. “At some point, you get down to the better-valued loans of the deal. When we reach that point, there will be tremendous value in the remaining tranches,” Mr. Midanek said.
Other money managers are capitalizing on asset-backed securities that are not directly tied to the subprime market.
“There is a crisis of confidence regarding rating agencies and their models,” said Jim Dondero, president and co-founder of Highland Capital Management LP, a Dallas-based manager of structured loans, high-yield bonds and structured products. “The residential-mortgage-backed securities’ subprime models are turning out to not be accurate. That’s doesn’t mean that everything rating agencies model is wrong.”
Nevertheless, many of the complex securities backed by mortgage loans or corporate loans have been sold off, due in part to concerns that rating agencies were not properly valuing those securities.
Money managers are buying many of those securities and pooled vehicles at a discount, believing that they still have significant value. Collateralized loan obligations, asset-backed securities and higher-rated tranches of collateralized debt obligations offer attractive investments, depending on which money manager you ask.
“There’s opportunity, particularly in the CLO market,” Mr. Dondero said. “Right now, almost every CLO has no defaults and no anticipated defaults. Their debt tranches are trading well below par, and we’ve tried to take advantage of that.’’
Trading down
Investors’ fears about most things a rating agency scores have caused all of those products to trade down in sympathy, Mr. Dondero said. While the residential-mortgage-backed-securities models are changing and no longer support previous ratings or recovery assumptions, Mr. Dondero said, the rating agency models for CLOs and commercial-mortgage-backed securities were well tested in 1998 and 2002 by a significant increase in corporate default rates, and they proved sound.
Other investors are also finding opportunities in portions of the securitized market that have been affected “but are not directly in the cross hairs of subprime,” said David Torchia, a portfolio manager for Stone Harbor Investment Partners LP of New York.
Mr. Torchia said his firm is buying commercial-mortgage-backed securities, “mostly in the AAA-rated area.”
“Spreads for commercial-mortgage-backed securities have widened significantly, because investors are looking to shed risk,” he said.
