Analysis: U.S. mortgage funds emerge even as housing stays weak
NEW YORK (Reuters) - The U.S. housing market may still be in the doldrums, but funds that are betting on big gains in mortgage-related investments are a hot ticket this year on Wall Street.
A number of hedge funds, asset managers and investment banks have launched vehicles dedicated to investing in the mortgage sector, often in securities backed by those loans, and sometimes focused on scooping up bargain-priced mortgages themselves.
The near-zero interest rate environment has investors starving for yield, and mortgage-related investments are seen as an attractive asset class with upside potential if the housing market picks up.
And even if home sales and prices don't recover, mortgage-backed securities still perform well as they provide higher yields relative to Treasuries and are appealing against a stable rate policy. A substantial risk would occur if interest rates rose abruptly and the U.S. economy weakened substantially, resulting in a spike in mortgage defaults.
Magnetar Capital Management, Neuberger Berman, Morgan Stanley, Goldman Sachs Group Inc and Stark Investments have all rolled out mortgage funds since the beginning of the year.
Other large investment managers have also been ratcheting up their mortgage exposure, including DoubleLine Capital and PIMCO.
This is not a return to the heady days of the subprime mortgage boom when banks were furiously competing to create sophisticated securities that ultimately imploded and led to the financial crisis. Rather, investors are showing an appetite for high-quality mortgage securities that have been beaten down and are now seen as having value as the housing market begins to find a bottom.
"There has definitely been a pick-up in investor interest in the asset class and the amount of interest has caused managers to want to come to market with a product because they know there is an appetite for it," said Michael Roth, co-founder of Stark, a $2.4 billion hedge fund.
"Where does the yield-hungry investor go to whet their appetite? Investors were waiting to see if they could get yield in other places and found it was not happening."
These new funds are investing mainly in mortgage securities and the home loans themselves. In some portfolios, there's also distressed residential loans and real estate properties.
Last year during the equity market tumult, mortgage-focused funds performed strongly - up 9.2 percent - while the average hedge fund was down 5 percent, according to eVestment|HFN, which tracks hedge fund flows and performance.
Average home prices across the country were back to late 2002 levels in February, according to the S&P/Case-Shiller composite index of 20 metropolitan areas, issued on Tuesday. However, there were some signs that prices may be stabilizing, with a 0.2 percent gain on a seasonally adjusted basis that month.
Wisconsin-based hedge fund Stark launched its Stark Mortgage Opportunities fund in the first quarter and has already raised $100 million with a target of $300 million, according to a source familiar with the portfolio. The Arizona Public Safety Personnel Retirement System committed up to $40 million in Stark's new vehicle.
The mortgage fund, which will invest in the gamut of mortgage-backed securities, was created in large part as a response to investors looking to put money to work in that asset class. Stark raised a fund in 2011 for a short-term trade against subprime bonds. Stark co-founder Roth decline to comment on his new fund.
Magnetar Capital Management, a $9 billion hedge fund known for earning big money by shorting tranches of subprime securities it sponsored during the housing bubble, also launched a new MBS-focused fund in March. Magnetar said in an email response that its portfolio was "market neutral" during the crisis.
The Magnetar Mortgage Securities Fund, which was created in response to investor demand according to a person familiar with the firm, had raised over $100 million as of March 13, according to a regulatory filing.
Hedge funds are not the only ones pouncing on mortgage assets.
Morgan Stanley Investment Management launched not one, but two separate funds dedicated to mortgage-related investments during the first quarter.
Goldman Sachs began raising funds for a U.S. Housing Recovery Fund, which will invest in non-agency mortgage-backed securities, including the subprime bonds that burned many money managers during the financial crisis.
Neuberger Berman recently launched its Preservation Residential Mortgage Fund, which will invest in distressed residential assets, from loans to real estate, including distressed residential mortgage loan workouts.
"On an absolute basis, both distressed MBS and home loans are still cheap relative to any other high yield sector," said Terrence Glomski, a managing director at Neuberger Berman, which manages $193 billion in assets, who declined to comment on the new fund.
SUBPRIME SEDUCES AGAIN
On the other end of the credit spectrum, even so-called subprime mortgage bonds are attracting interest.
"There is no shortage of money to be put to work in the distressed loan space," said Frank Pallotta, Executive Vice President of Loan Value Group, who works with hedge fund investors focused on consumer mortgages.
Subprime mortgage bonds, a historically volatile class of securities, rallied in the first quarter of 2012. The Markit ABX.HE.AAA.06-1 tradable credit default swap index rose about 3.3 percent in the first three months of the year, after falling 3 percent in the second half of 2011. That Markit index references a basket of 20 subprime RMBS with an original rating of AAA that were issued to market in the second half of 2005.
Faisal Syed, who launched global credit-focused Pamli Capital Management in 2011 after five years with Highbridge Capital Management, scooped up battered non-agency U.S. mortgage bonds in the second half of last year when the European sovereign debt crisis erupted.
"As the non-agency mortgage market came under stress in mid-2011, we found that certain securities became attractively priced with loss-adjusted yields higher than those of risky corporate or sovereign credit," said Syed. "These yields can be achieved with no improvement in housing. However, if the housing market begins to improve, we can see significant upside."
(Edited by Jennifer Ablan and Andre Grenon)
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