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Funds News

U.S. hedge fund adapts to stages of credit crisis

LONDON (Reuters) - U.S. hedge fund firm Structured Portfolio Management has designed a series of strategies to play the credit crisis, each geared to take advantage of a different stage.

“For us, it’s a continuous process that has been exploitable at very many points along the way,” said Don Brownstein, founder and chief executive of the Stamford, Conn.-based manager, which focuses on mortgage-backed securities and has about $1.2 billion (600 million pounds) in assets under management.

In February 2007, it opened a fund to short subprime mortgage securities. That fund has now been shut down after paying its investors a 186 percent return, Brownstein said in a telephone interview.

In May 2007, it started another fund as a play on U.S. interest rate volatility.

“As soon as the subprime thing blew in February, we knew that the next thing would be that volatilities would go through the roof,” Brownstein said. “We were fortunate to be right about that as well.”

In September 2007, Structured Portfolio Management started a directional mortgage credit fund to take advantage of dislocations in mortgage and structured credit markets due to a lack of liquidity.

The fund, using low leverage levels, bought triple-A and double-A paper at discounted prices from banks and other forced sellers. It experienced some losses as prices fell further, although “nothing horrific” because it had the protection of a hedge, Brownstein said. “These will pay off handsomely.”

PREPAYMENT PLAY

As for further plays, senior tranches of securities probably hold the most interest now, he said.

“If you can pick up a large liquidity premium, and these bonds are senior and would require a horrific outcome to suffer any loss in principal and the spreads are quite good, that’s a reasonable thing to do.”

But the firm is “leaning in the direction of waiting a while longer” before buying distressed mortgage securities, he said. “This is not the kind of stuff you want to fool around with. There are just way too many ways you can end up in a heap of pain.”

In March 2008 the firm started its latest fund to focus on a knock-on effect of the crisis relating to prime mortgage prepayments.

Deteriorating U.S. house prices and tougher rules for taking out new mortgages are likely to lead to a slowdown in prepayments on existing mortgages, he said. The fund is, therefore, investing in interest-only paper, which benefits from a prepayment slowdown.

“We specialize in prepayments and have for 10 years,” Brownstein said, adding that such expertise is important in the current environment.

“In the residential mortgage space, there are not 10,000 public corporations, there are 100 million homeowners, and each of those has a separate story,” he said.

“In order to predict outcomes with any real hope of success, you are going to need to know something about the facts on the ground, which is to say what’s going on in Dubuque as opposed to Des Moines.”

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