From staid German banks to high-flying U.S. hedge funds, many investors have been hit hard by imploding mortgage bonds. But another group of money managers are winning fame -- and fortune -- for shorting the market after shrewdly predicting what would happen when banks loaned tens of billions of dollars to people with low incomes and no documentation to buy homes.
Among the prominent winners are New Yorkbased Paulson & Co. and Dallas-based Highland Capital Management (see page 90 for related story). Less well known among this savvy troop are hedge fund managers Kyle Bass, 37, of Hayman Capital Partners in Dallas and Mark Hart, 35, of Fort Worthbased Corriente Advisors. Sensing the impending subprime debacle, the two friends last year decided to team up to comanage the Subprime Credit Strategies Fund, initially a $105 million pool of capital, to speculate on a collapse in subprime housing. Their investors were mainly other hedge fund managers.
Bass and Hart purchased more than $1 billion in credit derivatives that would pay out if subprime bonds were to default. Their highly leveraged fund could have taken huge hits if subprime had not blown up. Instead, the fund has quadrupled in value, to more than $400 million, as the value of subprime bonds has plummeted and the costs to buy protection against defaulting bonds has surged.
"I thought residential real estate was the biggest risk in the market due to the parabolic appreciation of prices," says Hart.
Bass (no relation to the famous Texas oil family), a onetime Bear, Stearns & Co. senior managing director, set up hedge fund Hayman Capital, which invests in equities, corporate credit and mortgage bonds, in February 2006 after four years in institutional equity sales for Legg Mason in Dallas. Hart, a global macro specialist, founded Corriente in 2001 after leaving Texas hedge fund Tarpon Advisors, where he was a portfolio manager. Neither manager would comment on the Subprime fund's performance.
Bass sees the losses in subprime mortgages as just the start of a wider U.S. malaise. In a letter sent to investors at the end of July, he called the packaging of subprime mortgages into collateralized debt obligations the "greatest bait and switch of all time." He thinks that foreign investors -- such as Asian central banks upset over subprime losses, the dollar's depreciation and the poor performance of the rating agencies -- will sell off U.S. holdings and stick closer to home. That, he says, has led him to short U.S. consumer-based equities, as well as preferred shares and debt, and to go long non-U.S. debt and equities. Bass and Hart are also keeping their subprime short positions, anticipating more losses -- and heartache -- for investors globally.