Lahde Capital made one of the most successful hedge fund bets of all time in 2007, delivering a near 870% return, shorting subprime. Andrew Lahde’s full letter to investors is available after the jump.
By way of a few brief highlights:
The hugely successful Lahde real estate funds are already being wound up, as per an announcement made a few months ago. And have now all closed their short positions on the ABX.
But Lahde Capital is still shorting commercial mortgages, and will continue to do so through 2008. Put neatly:
Risk premiums for this type of debt have skyrocketed as exhibited by the CMBX. If you dramatically increase the risk premium for an asset class, especially one that is so heavily financed, the value of that asset class must fall. End of story.
As well as which, the short credit fund, already looks to be delivering results, having bet against the muni bond market:
We shorted the general obligations (via credit default swaps) of California, Florida, and Michigan - sort of an appetizer plate for the feast to come. We do not necessarily expect any of these states to file for bankruptcy. However, as their respective economies fall further into the toilet, we expect that the risk premiums for their debt will rise. This is how we make money.
We have a few more tricks up our sleeves with regards to shorting credit. We cannot share these with you at this time, as we have not yet executed trades in the latest space we are studying. Until we trade we would rather not tip off all the readers of this letter to our next great idea.
Personally, Andrew Lahde, may too, have already profited from another rather successful bet. He reportedly started putting profits from Ladhe’s real estate fund into Gold and other precious metals in November.
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February 28, 2008
Where should I start? It would be easier at this point to write about which credit markets have not been negatively affected by the “credit crisis,” than to write about the ones that have. That is, virtually all credit markets have been affected, including Treasuries. Why? Treasuries are enjoying an artificial, flight to safety bid right now, which is driving down their yield. Meanwhile, inflation is rearing its ugly head. It is conceivable that these bonds will see a spike in yield as inflation continues to wreck havoc on the economy. Thus, investors who thought they were playing it safe, will also get burned. What a fun situation, for us anyway.Below are net returns for our funds through January 31, as well as estimates for month to date net performance for February.
February 2008 Month to Date Estimates
US Residential Real Estate Hedge V - Class A = 5%
US Residential Real Estate Hedge V - Class B = 17%
Commercial Real Estate Hedge - Class A = 17%
Commercial Real Estate Hedge - Class B = 15%
Short Credit Fund = 9%
U.S. Residential Real Estate Hedge V
Stick a fork in it. It is done, over, liquidated. February 15th marked the day that we unwound the last of our ABX positions. We have now been paid all amounts due on our ABX positions by our counterparties. We unwound our credit defaults swaps on our counterparties after we were paid and expect these final payments early next week.
The decision to liquidate the fund does not reflect my opinion of the residential real estate market or the market for subprime backed debt. I strongly believe both have much further to fall. The decision had to do with the risk/return characteristics. While it could easily be said that Lahde Capital is/was short real estate, short credit and short the economy, the one focus that underlies all of this is our ability and desire to identify and buy cheap options, before they become expensive.
I have often likened credit default swaps to puts on bonds, with a strike price of 100. Thus, if we were holding an ABX position that was priced at 30 cents on the dollar, we really owned a put worth 70 cents. While I believe that this particular put might increase in value to 75, 80 or 85, it was not worth tying up that much capital to wait for that price to be reached. Instead, we would rather short something in the Short Credit Fund, priced at or close to par. In doing so, we have less capital at risk and less potential downside, while the upside for a short portfolio is still great and very likely in our minds.
Commercial Real Estate Hedge
The Wall Street Journal published an article on February 22, 2008 regarding the CMBX. Part of the title was a quote from someone, “[It] doesn’t make sense.” The person quoted was referring to the dramatic drop in prices for virtually all CMBX indices, absent any significant losses surfacing, yet. I’d like to use an analogy from Peter Schiff’s book. If the commercial real estate market was a beach ball, picture my arm holding the ball. If I take my arm away, everyone knows that ball will fall to the ground. However, many foolishly believe that somehow if you take cheap financing (my arm) away, the ball will remain afloat. Risk premiums for this type of debt have skyrocketed as exhibited by the CMBX. If you dramatically increase the risk premium for an asset class, especially one that is so heavily financed, the value of that asset class must fall. End of story.
The losses will materialize. Admittedly I don’t have a clue how severe the losses will be. I don’t have a model that can correctly predict all the variables. Luckily no one else on the planet has such a model either. I gave up on the ability of models to correctly predict the value of securitizations a few years ago. I do know one thing though. It is safe to assume a market is dead when deal volume falls to zero, as was the case with CMBS issuance during January 2008.
There are always only three investment decisions - buy, sell or do nothing. The latter being the favorite course of action for myself, as well as others like Warren Buffett. Going back to the “cheap option” theme, there are no cheap options to buy in the CMBX space. Thus, we sit and wait for the next shoe to drop.
Short Credit Fund
Risk premiums on virtually all of our positions increased so far this year. Certain positions that we entered over the past few months no longer offer attractive entry points. However, we continue to search for and find new positions that offer low risk, with the potential to make outsized returns should our dire predictions materialize. So far, most of our predictions have occurred or are looking like a sure thing for the near future.
Corporate credits are getting pounded. Bank and broker credits have serious issues. As of late, even municipal credits have faced serious problems. Municipal credits are our most recent trade. We shorted the general obligations (via credit default swaps) of California, Florida, and Michigan - sort of an appetizer plate for the feast to come. We do not necessarily expect any of these states to file for bankruptcy. However, as their respective economies fall further into the toilet, we expect that the risk premiums for their debt will rise. This is how we make money.
We have a few more tricks up our sleeves with regards to shorting credit. We cannot share these with you at this time, as we have not yet executed trades in the latest space we are studying. Until we trade we would rather not tip off all the readers of this letter to our next great idea.
Transparency
We would love to open our books to you, but our investors are not the only ones reading this letter. We are aware of copycat strategies and prefer to let them try to copy us with as little information as possible. Likewise, we get constant calls for mid-month performance estimates. I am fundamentally against midmonth estimates. After all, the funds have a 12-month lock up. So, it is a long-term investment. I believe investors should be able to sleep at night without knowing the exact value of every investment they own - I do. Probably more important than my preference for long-term focused investors, is the intra-month volatility of our funds. Nearly every time we have offered mid-month performance estimates, our end of month performance happens to be lower. We do not like to disappoint. Nonetheless, I acquiesce to the demands.
We will begin providing mid-month performance estimates on or about the 15th of the month.
Thank you again for your investments and your confidence in our abilities to stay ahead of the credit contraction, one CDS contract at a time.
Best regards,
Andrew Lahde, CFA
Portfolio Manager
Lahde Capital Management, LLC
