Key Takeaways
- • Providence MBS fund returned 1.4% in March 2013 and 5.4% year-to-date, benefiting from underperformance in agency mortgage-backed securities and longer-dated U.S. Treasuries through March 31, 2013.
- • Regulatory changes, specifically the upcoming implementation of the Volcker Rule restricting proprietary trading desks, are creating opportunities in fixed income arbitrage strategies including agency mortgage trading and credit arbitrage.
- • Mariner Investment Group, a $10 billion multi-strategy hedge fund, is positioning for higher volatility and rising interest rates by trimming low-yielding bonds and emphasizing fixed income and credit arbitrage strategies.
- • Market participants are pricing in the potential end of the Federal Reserve's Large Scale Asset Purchases (LSAP) program following Fed officials' discussion of asset purchase tapering, reversing earlier expectations that drove MBS and long Treasury outperformance.
- • Hedge fund managers view constrained proprietary trading at traditional banks as a structural market inefficiency creating alpha opportunities in fixed income markets previously dominated by bank prop desks.
Summary
The regulatory restrictions on proprietary trading desks are reshaping fixed income markets and creating investment opportunities for hedge fund managers. With the Federal Reserve maintaining unchanged interest rates and continuing its asset purchase program of longer-dated Treasuries and low-coupon agency mortgage-backed securities, market dynamics shifted sharply as investors began pricing in an eventual end to the LSAP program. This repricing, triggered by Fed officials' discussion of potential asset purchase tapering in the prior quarter, has pressured both agency MBS and longer-dated U.S. Treasuries, which underperformed year-to-date through March 31, 2013.
Providence, a mortgage-backed security fund specializing in MBS arbitrage strategies, has capitalized on this underperformance, returning 1.4% for March 2013 and 5.4% year-to-date. According to Russ Jeffrey, Providence's Principal, CEO and Chief Investment Strategist, the stretched valuations of long levered MBS trades held by some investors suggest limited upside ahead, positioning arbitrage-oriented strategies as more attractive alternatives.
Mariner Investment Group, a $10 billion multi-strategy hedge fund managed by founder and Chief Investment Officer William Michaelcheck, is similarly positioning its portfolio for volatility and potential rate increases. Michaelcheck recommends trimming low-yielding corporate and government bonds in favor of fixed income trading-oriented strategies, including fixed income and credit arbitrage, agency mortgage trading, and volatility trading. The regulatory environment—particularly the upcoming implementation of the Volcker Rule—has made these arbitrage strategies increasingly attractive by constraining bank proprietary trading desks that historically dominated fixed income markets. This structural shift is creating opportunities for hedge funds to capture alpha in the fixed income space through strategies that were previously crowded with bank capital.
Providence, a mortgage-backed security fund specializing in MBS arbitrage strategies, has capitalized on this underperformance, returning 1.4% for March 2013 and 5.4% year-to-date. According to Russ Jeffrey, Providence's Principal, CEO and Chief Investment Strategist, the stretched valuations of long levered MBS trades held by some investors suggest limited upside ahead, positioning arbitrage-oriented strategies as more attractive alternatives.
Mariner Investment Group, a $10 billion multi-strategy hedge fund managed by founder and Chief Investment Officer William Michaelcheck, is similarly positioning its portfolio for volatility and potential rate increases. Michaelcheck recommends trimming low-yielding corporate and government bonds in favor of fixed income trading-oriented strategies, including fixed income and credit arbitrage, agency mortgage trading, and volatility trading. The regulatory environment—particularly the upcoming implementation of the Volcker Rule—has made these arbitrage strategies increasingly attractive by constraining bank proprietary trading desks that historically dominated fixed income markets. This structural shift is creating opportunities for hedge funds to capture alpha in the fixed income space through strategies that were previously crowded with bank capital.
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