Hedge Fund Staged Credit-Based Investments

The hedge fund firm Structured Portfolio Management has tried to take advantage of the different stages of the recent and on-going credit problems. Initially, the fund shorted subprime mortgages back in February of 2007. In May, the fund took bets on volatility increasing. In September, they started buying discounted AAA and AA rated paper from banks and others forced to liquidate. Senior tranches were also looked at in an attempt to pick up the liquidity premium, but still maintain some safety with the senior tranches. Hindsight is always 20-20, but the fund certainly had a nice track record and made some smart moves. Currently, the fund is investing in interest-only paper, hoping to benefit from the recent slowdowns in the mortgage market. This paper typically has prepayment risk, such that you will need to reallocate funds earlier than expected, often at a lower yield. Nonetheless, current mortgage problems, and the subsequent stricter regulations placed on lenders and borrowers, are making new loans and refinancing more difficult and expensive. For funds, this may be an opportunity to lock in a higher rate for a longer than expected period, often boosted by getting this paper at a discount.