The U.S. mortgage market has been very good to Anthony “the Mooch” Scaramucci.
In the past few years, the Federal Reserve’s unprecedented stimulus contributed to some of the biggest returns for money managers investing in mortgages. Then housing prices soared, lifting the most beaten-up home-loan securities. And Scaramucci’s SkyBridge Capital, which invests $6.2 billion in hedge funds, was along for the ride. Mortgage investments fueled returns of about 38 percent over the past two years, about triple the industry average.
Even with SkyBridge now calling the stock market the best place to generate returns, its second biggest strategy is mortgages, which make up 38 percent of allocations, down from 70 percent a year ago, though still one of the highest for investors that farm out money to hedge funds. After benefiting as the Fed intervened in financial markets with low interest rates and bond buying, SkyBridge sees opportunities in government-backed mortgage debt during the retreat and is sticking with housing market wagers.
“We still like mortgage-backed securities,” said Troy Gayeski, a partner at New York-based SkyBridge. Returns of 6 percent to 10 percent are likely from nongovernment backed debt as real estate continues to recover, he said, although the “violent move up in housing has already occurred.”
The firm invests with managers such as Axonic Capital LLC, Seer Capital Management LP and Ellington Management Group LLC, returning more than 14 percent last year after gaining about 21 percent in 2012, according to regulatory filings and investor notices. The industry on average returned 7.4 percent in 2013 and 5 percent the prior year, according to the Bloomberg Hedge Funds Aggregate Index.
SkyBridge, founded in 2005 by Scaramucci, 50, got the biggest windfalls two years ago from managers who traded and invested in the $5.4 trillion market for government-backed agency mortgage securities such as Fannie Mae and Freddie Mac-guaranteed bonds. The following year, managers in the $800 billion non-agency market were the biggest winners in the mortgage market as house prices jumped by the most since 2006.
Last year, managers that trade U.S.-backed housing debt struggled as investors speculated the Fed would slow its debt purchases and concern grew that Obama administration policies and rising home prices would make it easier for certain homeowners to refinance, reducing the value of their investments. Gayeski said agency mortgage managers can now benefit from bets against the debt as the central bank retreats.
The funds also can make about 10 percent to 15 percent annual income from bets on investments known as inverse interest-only notes, he said. Rising borrowing costs could lessen the impact of policies that enable wider refinancing, since it’s less worthwhile for borrowers to replace their mortgages.
“As interest rates go materially higher, the political risk is less of a concern,” he said.
The average rate for a 30-year fixed mortgage has risen to 4.41 percent from 3.35 percent in May, according to Freddie Mac.
In the non-government-backed market, “if you’re expecting to make 15 percent to 20 percent, that’s not going to happen, it’s just not mathematically possible” anymore, though above-average returns are still achievable, said Gayeski.
The firm sees a strengthening economy creating opportunities in equity investing, especially for managers pursuing strategies involving “hard corporate catalysts” such as mergers, spin-offs and asset sales.
SkyBridge directed $490 million from its main fund to John Paulson’s funds in the six months ended Sept. 30, regulatory filings show. It cut holdings in the Pine River Fixed Income Fund, JLP Credit Opportunity Cayman Fund Ltd. and pulled all $60 million it had in the SPM Core Offshore Fund Ltd., which invests in mortgages.
Over the past three years, Pine River Capital Management LP has diversified beyond the residential mortgage-bond specialty that had propelled much of its growth since the financial crisis, said Colin Teichholtz, Pine River’s co-head of fixed- income trading.
“That’s not to say there’s not a great opportunity set in mortgages,” he said. “It’s just not a complete capital vacuum to the same degree that it was going back a few years.”
Pine River also sees non-agency returns being limited by higher prices and slower gains in home values, and the Fed’s retreat from the agency market potentially creating dislocations, he said. The firm’s $3.4 billion fixed-income fund gained about 10 percent last year, an investor notice shows.
Even if U.S. property appreciation slows or reverses, investors such as Ellington that are analyzing specific markets can benefit as areas such as some Florida markets catch up after lagging behind, chief executive officer Michael Vranos said.
“We don’t think about national home prices: We think about hundreds of separate markets and economies,” said Vranos. His Old Greenwich, Conn.-based company’s flagship Credit Opportunities Fund and similar accounts, with $2.9 billion of assets, returned about 15.5 percent in 2013, according to a person familiar with the results, who asked not to be named because the returns are private.
Many of the mortgage hedge funds started up during or after the crisis are diversifying beyond beaten-down residential securities as they mature. Seer Capital, which oversees $2.2 billion, last year increased its investments in debt such as European small-business-loan bonds, commercial mortgage-backed securities and collateralized loan obligations and began buying soured mortgages not packaged into bonds.
“The supply and demand dynamic has shifted in their favor” relative to securities backed by the debt, said CEO Philip Weingord.
The New York-based firm’s main fund returned 12.2 percent last year, according to a person familiar with the results.
Returns of 20 percent or more in securitized debt are unlikely after the rallies, said Clayton DeGiacinto, chief investment officer of Axonic, a $2 billion structured-credit asset manager based in New York. Hedge funds can still make above-average returns by investing in and trading the securities partly because of new rules that are restraining banks’ activity, he said.
“We’re never going to go back to the way the market was in 2006,” said DeGiacinto, a former Goldman Sachs Group Inc. trader. “Those days are long gone.” His main fund returned more than 12 percent in 2013, a person familiar with the results said. With banks pulling back, it’s become easier for “holders like us, who’ve built up an expertise in this asset class.”
SkyBridge’s annual SkyBridge Alternatives Conference is the largest annual U.S. symposium for hedge funds. Scaramucci’s ability to network and draw big names to the annual event has earned him the nickname “the Mooch” in the hedge-fund industry.
SkyBridge is often asked why it doesn’t devote more attention to managers looking to invest in areas such as distressed European assets, according to Gayeski. Mortgage managers are a big reason why.
“The answer is the remaining opportunity in mortgage- backed securities,” he said. Those “we believe offer equally compelling returns, with more liquidity and less dependence on an economic rebound.”