Download Document

Bubble Talk
Presentation for VBA
May 2008
Wouter ten Brinke, CFA
Agenda
• Introduction Theta Capital Management
• Financial alchemy: growth of the non-bank banking system
• Deflating the credit bubble: the cycle in reverse
• Long/short investing: how to benefit from upcoming opportunities
Page 2
Theta Capital Management
Independent Hedge Fund Boutique
• Founded in January 2001
• Management of multi-hedge fund portfolios
• EUR 950m AuM in customized mandates & funds of funds
• EUR 600m in Medium Volatility strategy
• EUR 200m in Low Volatility strategy
• EUR 150m in Deep Value strategy
• Staff of 8 investment professionals and 4 support
• Research-driven investment process
• Advisory board of hedge fund experts
Page 3
Theta Capital Management
Products
Performance statistics since inception
Product
Return
p.a.
Vol
Sharpe
ratio
Inception
Theta Multistar Medium Volatility
10.34%
5.81%
1.29
Feb-04
6.10%
2.67%
1.23
Jan-04
VP Theta Hedge Funds Strategy
10.15%
5.11%
1.43
Jul-05
Vermeer Mid Volatility
10.88%
5.49%
1.47
Mar-03
Vermeer Low Volatility
6.29%
2.33%
1.49
Mar-03
11.33%
5.34%
1.59
Sep-01
7.10%
3.10%
1.38
May-05
31.55%
8.96%
3.21
Jul-06
Theta Multistar Low Volatility
Theta Client Portfolios *
Theta Master Fund **
Theta Deep Value Fund
* C omposite of Theta managed accounts
** Underlying fund for Theta Structured Products
Page 4
Agenda
• Introduction Theta Capital Management
• Financial alchemy: growth of the non-bank banking system
• Deflating the credit bubble: the cycle in reverse
• Long/short investing: how to benefit from upcoming opportunities
Page 5
Financial alchemy
Bank Balance Sheet
AAA
AA
Loans
Deposits
Equity
Source: Theta
Page 6
12 X leverage
Financial alchemy
CDO Balance Sheet
AAA
AA
Bonds / CDS
A
BBB
Equity
Source: Theta
Page 7
Financial alchemy
MBS Balance Sheet
AAA
AA
Mortgages
A
BBB
BBB-
Equity
Source: Theta
Page 8
Financial alchemy
CDO of ABS Balance Sheet
AAA
AA
ABS / MBS /
CDOs
A
BBB
BBBEquity
Source: Theta
Page 9
Financial alchemy
Monoline insurer Balance Sheet
AAA
AA
Financial
guarantees
A
BBB
BBBEquity
Source: Theta
Page 10
94 X leverage !
Financial alchemy
The result: a shadow banking system
• CDO’s turned low quality assets into combination of high and low
rated assets
• CDO’s provided additional capital to weak lenders, adding leverage
to the system
• CDO’s segregated risk takers from risk assessors (leveraged &
engineered pools of credit replaced old-fashioned credit analysis)
• All these vehicles are effectively non-regulated banks, not required
to hold reserves, except as negotiated with the rating agencies
• Agents had similar incentives: banks, rating agencies, CDO
managers
Page 11
Inflating the credit bubble
Leverage in US defies the long-term trend
(10% of GDP)
Page 12
Inflating the credit bubble
Freely available credit
• Low interest rates
• Relaxed lending standards
• Financial “innovation”
• CDO demand
More leverage / More buyers:
Decreasing
default rates
Increasing
asset values
Page 13
Source: Theta
• LBO
Hedge funds
• CDO
Other investors
Inflating the credit bubble
Traditional finance:
Rapid acceleration of
debt for productive use
Speculative finance:
Companies pay back
only interest
Minsky Moment:
Companies borrow more
to pay back interest
Lenders become cautious
Debt structures are no
longer accepted
Profitable companies
take on more debt
Companies pay back
interest & principal at
maturity
Ponzi finance:
Most debt is used to roll
over existing debt
Relaxed lending standards:
“Worst loans are made in
the best times”
High-profile entity has to
liquidate assets
Crucial element: it is the new liquidity that supports the asset values
and keep existing investors happy
Page 14
Source: Theta
Inflating the credit bubble
Financial Instability Hypothesis (Hyman Minsky, 1982)
• Financial structure becomes more fragile over periods of prosperity
• We fall in love with innovations (with no history, by definition)
• In prosperity, we are gradually testing the limits of the market, but
the adjustment and revaluation can be sudden and violent
2000
Page 15
2007
Agenda
• Introduction Theta Capital Management
• Financial alchemy: growth of the non-bank banking system
• Deflating the credit bubble: the cycle in reverse
• Long/short investing: how to benefit from upcoming opportunities
Page 16
Deflating the credit bubble: cycle in reverse
Catalyst: unexpected defaults
Reduced availability credit
• Higher interest rates
• Tigther lending standards
• Stop to financial “innovation”
• CDO demand halts
Less leverage / less buyers:
• LBO
Hedge funds
• CDO
Other investors
Decreasing
asset values
Page 17
Rising default
rates, lower
recovery
Deflating the credit bubble: mortgage credit
Long-term investment theme: US Housing market
Page 18
Deflating the credit bubble: mortgage credit
Long-term investment theme: US Housing market
Page 19
Deflating the credit bubble: mortgage credit
Long-term investment theme: US Housing market
S&P Case-Shiller US Home Price Index
20%
Home Price Appreciation (HPA) YoY
15%
10%
5%
0%
-5%
-10%
Page 20
Mar-06
Mar-04
Mar-02
Mar-00
Mar-98
Mar-96
Mar-94
Mar-92
Mar-90
Mar-88
-15%
Deflating the credit bubble: mortgage credit
Long-term investment theme: US Housing market
Mortgage
pool
Credit support for
ABX tranches
4y Cumulative
HPA
AAA
23.9%
-40%
AA
14.0%
-20%
8.6%
+5%
5.6%
+20%
A
BBB
BBB4.5%
0%
Source: Citi, Theta
Page 21
Deflating the credit bubble: mortgage credit
Long-term investment theme (2006): US Housing market
Moody’s expected loss:
0.001%
0.025%
0.180%
1.309%
Page 22
Who’s next? The weakest hands
Funding liquidity risk
• Funding risk = liabilities reprice before assets reprice
• Who can post collateral when the market moves against him?
• Weak hands: the importance of long-term funding (SIV, CLO, TRS)
Counterparty risk
• CDS market has grown 10X in last 4 years
• Who is selling CDS? (source: BBA)
•
•
•
•
•
Page 23
34%
21%
15%
14%
16%
Banks
Insurance companies
Hedge funds
Securities houses
Other
Who’s next? Corporate credit
Compostion of High Yield Market and Default Rates
60%
Default Rate (%, RHS)
% New HY Issues Rated B- or below
51%
50%
41%
39%
40%
33%
33%
30%
30%
30%
27%
23%
20%
34%
21%
19%
18%
14%
14%
10%
0%
1993
Page 24
1994
1995
Source: E. Altman, NYU Salomon C enter
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
Who’s next? Corporate credit
Never before have we turned the credit (and economic) cycle with so much
leverage in the system
Page 25
Who’s next? Commercial real estate
Lending standards are tightening...
Page 26
Agenda
• Introduction Theta Capital Management
• Financial alchemy: growth of the non-bank banking system
• Deflating the credit bubble: the cycle in reverse
• Long/short investing: how to benefit from upcoming
opportunities
Page 27
How to benefit?
1. During the credit unwind (short positions):
•
Mortgage credit: residential & commercial, US & Europe
•
Other US consumer credit: credit cards & autoloans
•
Corporate credit: focus on HY and lower rated tranches with default risk
rather than spread risk
2. After the credit unwind (establish deep value long positions):
•
Distressed ABS
•
Distressed corporate credit
3. More volatility/price dispersion in all risky assets (example trades):
Page 28
•
ABS, corporate debt, equity long/short
•
Emerging markets sovereign debt
•
European sovereign debt
The credit opportunity set
Page 29
Long/short emerging markets
No broad decoupling but divergence between countries
Components: inflation, fiscal balance, debt/GBP ratio, current account, FX reserves, trade/GDP, FDI/GDP
Page 30
Long/short emerging markets
Example portfolio
Page 31
European Sovereign Divergence
The Stability Pact is dead and the ECB will not bail out
Page 32
European Sovereign Divergence
“EU bond markets begin to diverge”
Wall Street Journal, 7 Feb 2008
“Europe ministers call on France to meet budget pledge”
Bloomberg, 12 Feb 2008
Page 33
Theta Capital Management
Contact Details
Theta Capital Management B.V.
Johannes Vermeerstraat 9
1071 DK Amsterdam
The Netherlands
Telephone:
Fax:
E-mail:
Website:
Page 34
+31 (0) 20 5722733
+31 (0) 20 5722744
[email protected]
www.thetacapital.com