Several Skills Important When Shorting - Featuring Richard Travia

Several Skills Important When Shorting - Featuring Richard Travia

Hedge Funds use Specific Criteria for Prime Broker Selection

Prime Broker Selection - Featuring Richard Travia

Flash Update - Short-Biased High Yield Portfolio

Cracks in High Yield Companies Show Up Early  

Yesterday we tweeted about Kodak emerging from Bankruptcy.  Kodak was founded in 1880, at its peak employed more than 60,000 employees and filed for bankruptcy in January 2012.  So, was bankruptcy the catalyst for this storied American bellwether's bond and equity prices to plummet?  No, it was not...In early 2011, Kodak unsecured bonds traded at PAR.  It was already an older-line, dead or dying business that had significant competitive headwinds...It already had YEARS-long delays in embracing digital camera technology...It already was being weighed down by high pension costs...It had already expanded its adviser's duties to explore bankruptcy, among other options, and drew down on a $160 m credit line...It wasn't until September 30, 2011 when Kodak publicly confirmed hiring restructuring lawyers that the equity fell below $1/share.  The unsecured bonds fell to the 10-20 range, and the equity eventually went to zero.  Kodak is merely an example of the dying businesses we focus on that have weak fundamentals, are not macro-timing oriented, and have multiple catalysts to drive bond prices lower.

We have found a tremendous amount of catalyst-driven, fundamentally weak, high yield credits that together have created a tremendous opportunity to be short.  

Tradex Global Advisory Services, LLC

investorrelations@thetradexgroup.com 

203-863-1500

@Tradex_Global

MBA Mortgage Applications

TRADEX GLOBAL INTERNAL COMMENTARY

Mortgage applications fell again for the third straight week.

In the week ending August 23rd, mortgage applications for both refinancing and home purchase fell 2.5%, following a 4.6% decline the prior week.  The 30-year conforming mortgage rate rose to 4.80%, the highest level so far this year.  The “refinance” component (…and the number most important to our IO portfolios) was down 5.4% last week.  The refinance share of total mortgage activity slid to 60%, the lowest level in two years!  All these numbers and a soft “new” homes number has the rates market looking for a clear sign of what the Fed will do with tapering.  We are not going to even take a guess as to whether tapering starts in September, December or early in 2014.  All we know for sure is that it is going to be sooner than later.  The IO component of the Tradex Liquid Real Estate Portfolio, which has positive convexity to rates, is already showing positive results within certain collateral.  Some securities have risen approximately 10 to 15% over the last two months as rates backed up and mortgage refinancing’s fell off the cliff.  The floating rate RMBS component of the Portfolio is enjoying much improved fundamentals, as is the CMBS component.  In CMBS, where most bonds are fixed rate, the interest rate exposure is mostly swapped (hedged) out, putting the entire Liquid Real Estate Portfolio in a potential ‘goldilocks’ environment.  That being said, we will still closely monitor Washington and the FHA for any new developments or any changes in HARP that might affect IO’s.  Keep nimble and enjoy the Labor day holiday – Michael Beattie

EXTERNAL RESEARCH COMMENTARY

Applications for U.S. home loans fell for a third straight week as average mortgage rates hit their highest level this year, although demand for purchase loans increased, data from an industry group showed on Wednesday. The Mortgage Bankers Association said its seasonally adjusted index of mortgage application activity, which includes both refinancing and home purchase demand, fell 2.5 percent in the week ended August 23, after sliding 4.6 percent the prior week. The decline came as 30-year mortgage rates rose 12 basis points to 4.80 percent, the highest they have been so far this year, according to MBA data. The survey covers over 75 percent of U.S. retail residential mortgage applications, according to MBA. Borrowing costs have climbed by more than a percentage point since late May on the view that the Federal Reserve will soon reduce its monthly bond purchases, which have kept a ceiling on rates. The Fed began the bond purchasing program nearly a year ago to boost a sluggish recovery in the U.S. economy. Higher rates have dissuaded borrowers from refinancing existing home loans. The refinance index fell 5.4 percent last week, and the refinance share of total mortgage activity slid to 60 percent, the lowest since April of 2011. The gauge of loan requests for home purchases, a leading indicator of home sales, held up better, rising 2.4 percent. Housing has been a bright spot in the U.S. recovery, with prices rising steadily since early 2012. But economists expect the pace of that increase to slow as the year winds down. A separate report last week showed sales of new single-family homes fell sharply in July to their lowest level in nine months. That has injected some uncertainty into the debate about when the Fed will start slowing its stimulus. Markets largely expect the Fed to pull back next month, though many analysts say the U.S. central bank will think twice about higher long-term interest rates if there is evidence the rates are hurting housing. Still, rates remain low by historical standards and most economists do not expect the higher costs to end the recovery altogether. In the short-term, it could also spur potential buyers to act before rates rise further.

Tradex Global Advisory Services, LLC

investorrelations@thetradexgroup.com 

203-863-1500

@Tradex_Global

Several skills important for shorting stocks say hedge funds - Part 2 - Featuring Richard Travia

Richard Travia, Tradex
Few investors are truly comfortable being short. That goes for individuals as well as institutions. As investors we simply are not wired to approach short selling with such ease.

But as allocators in a performance-driven world, being a talented and aggressive short-seller is a necessary trait that is very much part of our DNA - akin to survival skills in the ‘kill or be killed' investment jungle.

Tradex has historically made some of its best returns being short various assets classes, such as subprime mortgages, high yield corporate debt and equities, to name a few. A certain amount of aggressiveness was needed to pull off these trades.

We feel aggressive, contrarian thinking should be an important part of every investment process and thesis and its development should help to build and support the short or long side of any trade.

Without understanding the bull and bear cases, one might find yourself being fed to the wolves.

While timing is always important - and gut feel plays a large role in that - a thoroughly researched investment case where true asymmetry exists can help offset the need for perfect timing for investors that have lost their crystal ball.

Our favourite types of short trades have mathematical asymmetry on their side. Mathematical asymmetry is about more than having a strong opinion - it means there are factual and mathematical limits to the losses and the probability of a gain is skewed positively.

We currently see shorting high yield corporate bonds as a mathematically asymmetric opportunity that needs to be pounced on.

Several skills important for shorting stocks say hedge funds

Author: Hedge Funds Review editorial

Source: Hedge Funds Review | 08 Aug 2013

Categories: Hedge Funds

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Wide range of skills needed to short successfully

Shorting requires a trader to balance conviction in an idea and the desire to see it through to a profitable outcome with real risk management discipline

Matt Taylor, Kortright Capital Partners
We approach our long and short investments with the same set of criteria and the same investment process. We focus on small and mid-cap stocks at interesting and complex points in their corporate lives. Specifically, we look for companies in industries where we can do deep fundamental work but where some element of complexity related to either the balance sheet or corporate activity is causing market participants to look the other way.

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Many event strategies do not lend themselves to short-selling because most corporate activity is at least designed to create shareholder value. However, the best corporate intentions do not always yield positive results.

We focus on several key questions when making short investments: is value being created or destroyed over a reasonable timeframe; is the market appropriately discounting either scenario; are the underlying fundamentals of the business a challenge relative to the company's valuation; and is the rest of the capital structure a potential problem for the value of the common equity?

Getting the answers requires an ability to analyse corporate event activity, levered balance sheets and business fundamentals. These are also the skills most relevant to our long investments.

However, making short investments requires an added dimension of risk management. Stocks can theoretically go up forever but can only go down to zero. That makes the risk/reward ratio of short investments negatively asymmetric relative to long investments.

The result is that shorting requires an additional skill: balancing one's conviction in an idea and the desire to see it through to a profitable outcome with real risk management discipline.

Anis Lahlou-Abid, portfolio manager of JP Morgan Europe Dynamic Long/Short fund
Shorting can be risky because of the inherent asymmetry in the trade: stocks go up more often than down and have unlimited upside, meaning potentially unlimited losses for the short trade. Takeover premiums and short squeezes are reminders of that.

Such was the case with Volkswagen in late 2008, when its stock went up five times (from €200 to €1,000) in less than two days making it briefly the world's largest company by market cap. Many investors with short positions lost a lot of money.

Yet, analysing our 10-year history of shorting in the JPM Europe Dynamic L/S fund, the reality appears different to conventional thinking. Provided a certain number of rules are strictly followed, shorts are not only a significant source of performance, they also reduce the volatility of returns as they are negatively correlated to longs.

The overriding rule is to avoid behavioural biases and rigorously follow trends and earnings. For example, after a decade of raising and beating expectations, Apple's first earnings downgrades signalled a change in trend while the stock was still a consensus long trading near $700.

Then, once a trend is established, ride your shorts until the trend reverses and remember to reload shorts as they are working, rather than closing them as the position becomes smaller.

Perhaps the most important rule is to diversify your shorts and avoid bid stocks: shorting is about having the right sizes across multiple names, not just one concentrated short. One or two profit warnings should more than offset 10 small squeezes and sideway moves.

Richard Travia, Tradex
Few investors are truly comfortable being short. That goes for individuals as well as institutions. As investors we simply are not wired to approach short selling with such ease.

But as allocators in a performance-driven world, being a talented and aggressive short-seller is a necessary trait that is very much part of our DNA - akin to survival skills in the ‘kill or be killed' investment jungle.

Tradex has historically made some of its best returns being short various assets classes, such as subprime mortgages, high yield corporate debt and equities, to name a few. A certain amount of aggressiveness was needed to pull off these trades.

We feel aggressive, contrarian thinking should be an important part of every investment process and thesis and its development should help to build and support the short or long side of any trade.

Without understanding the bull and bear cases, one might find yourself being fed to the wolves.

While timing is always important - and gut feel plays a large role in that - a thoroughly researched investment case where true asymmetry exists can help offset the need for perfect timing for investors that have lost their crystal ball.

Our favourite types of short trades have mathematical asymmetry on their side. Mathematical asymmetry is about more than having a strong opinion - it means there are factual and mathematical limits to the losses and the probability of a gain is skewed positively.

We currently see shorting high yield corporate bonds as a mathematically asymmetric opportunity that needs to be pounced on.

Topics: Hedge funds, JP Morgan, Short, Top story

MBA Mortgage Application 8/14/13

TRADEX GLOBAL INTERNAL COMMENTARY

The total number of mortgage applications was off by 4.7%, and the Refinance Index slid 4.4% from the previous week. We estimate that the refinancing of existing mortgages is off 40% from its peak. We also know that once the old deals that homeowners locked in go through the system, the end of the greatest refinancing wave in history will be over. This will bode well for our IO strategy, which is approximately 50% of the Tradex Liquid Real Estate Portfolio. These securities will have a huge upside as rates move up and at the same time we get a nice carry. The overall improvement in housing also bodes very well for our legacy RMBS bonds. We will not see the 25% returns in RMBS, but we will be very happy with a 10-12% return without the volatility we experienced in the early days of long RMBS. We are more excited about the improving fundamentals in CMBS; seeing that our manager is connected to a large private equity real estate firm, we are lucky enough to be able to have exposure to the mezzanine pieces of deals that other traders cannot re-underwrite. We expect high-teen returns in the CMBS strategy, and will increase exposure in the strategy. We have been careful not to push too hard to increase IO’s and CMBS, but we are at the inflection point and believe with the fundamentals in both strategies, we will have a better overall return than the 10.5% annualized return we have achieved in the last 3.5 years. All the best, have a great summer. Please feel free to call us to discuss and understand this opportunity. - Michael Beattie

EXTERNAL RESEARCH COMMENTARY

The number of mortgage applications filed in the U.S. last week dropped 4.7% from the prior week, the Mortgage Bankers Association said Wednesday. MBA also reported the refinance index fell 4.4% from a week earlier, while the seasonally adjusted purchase index fell 5.4%.

A run-up in interest rates had curbed some individuals' appetite to buy a new home and reduced the appeal of mortgage refinancing, though mortgage rates have steadied somewhat after a torrid increase this summer. The share of applications filed to refinance existing mortgages held steady at 63%. In the latest week, adjustable-rate mortgages, or ARMs, represented 6% of total applications. The average rate on 30-year fixed-rate mortgages with conforming loan balances declined to 4.56% from the prior week's 4.61%. Rates on similar mortgages with jumbo-loan balances slid to 4.57% from 4.64%. The average rate on 30-year fixed-rate mortgages backed by the Federal Housing Administration fell to 4.25% from 4.33%. The average rate for 15-year fixed-rate mortgages decreased to 3.6% from 3.66% in the previous week. The 5/1 ARM average declined to 3.36% from 3.39%. MBA's weekly survey covers more than three-quarters of all U.S. residential-mortgage applications.

Tradex Global Advisory Services, LLC

investorrelations@thetradexgroup.com 

203-863-1500

@Tradex_Global