PowerPoint Presentation by 513E0crv

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									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




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         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


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         Theta Capital Management
         Products

            Performance statistics since inception

                                                       Return           Sharpe
            Product                                              Vol             Inception
                                                        p.a.             ratio

            Theta Multistar Medium Volatility          10.34%   5.81%    1.29     Feb-04
            Theta Multistar Low Volatility              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
            Theta Client Portfolios *                  11.33%   5.34%    1.59     Sep-01
            Theta Master Fund **                        7.10%   3.10%    1.38     May-05
            Theta Deep Value Fund                      31.55%   8.96%    3.21     Jul-06
            * C omposite of Theta managed accounts
            ** Underlying fund for Theta Structured Products




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         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




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         Financial alchemy
                                  Bank Balance Sheet


                                                  AAA



                                                   AA



                           Loans                Deposits




                                                Equity     12 X leverage



                  Source: Theta
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         Financial alchemy
                                  CDO Balance Sheet


                                                 AAA




                                                  AA


                     Bonds / CDS
                                                  A


                                                 BBB




                                                Equity


                  Source: Theta
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         Financial alchemy
                                  MBS Balance Sheet



                                                 AAA




                                                  AA
                        Mortgages

                                                  A


                                                 BBB

                                                 BBB-

                                                Equity
                  Source: Theta
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         Financial alchemy
                                  CDO of ABS Balance Sheet



                                                     AAA




                                                      AA
                       ABS / MBS /
                         CDOs
                                                      A



                                                     BBB

                                                     BBB-
                                                    Equity
                  Source: Theta
Page 9
          Financial alchemy
                            Monoline insurer Balance Sheet



                                                   AAA




                                                   AA
                         Financial
                        guarantees

                                                    A



                                                   BBB

                                                  BBB-
                                                             94 X leverage !
                                                  Equity
                   Source: Theta
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          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
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          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



              Decreasing                                    More leverage / More buyers:
                                                            • LBO         Hedge funds
              default rates                                 • CDO         Other investors




                                   Increasing
                                   asset values



Page 13   Source: Theta
          Inflating the credit bubble


           Traditional finance:       Speculative finance:           Ponzi finance:              Minsky Moment:

            Rapid acceleration of       Companies pay back           Companies borrow more       Lenders become cautious
            debt for productive use     only interest                to pay back interest
                                                                                                 Debt structures are no
                                                                                                 longer accepted
            Profitable companies
            take on more debt
                                                                    Relaxed lending standards:   High-profile entity has to
                                        Most debt is used to roll                                liquidate assets
           Companies pay back           over existing debt          “Worst loans are made in
           interest & principal at
                                                                    the best times”
           maturity




           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                        2007




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          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:                            Rising default
            • LBO          Hedge funds                              rates, lower
            • CDO          Other investors                          recovery



                                         Decreasing
                                         asset values

Page 17
          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%
                  -15%
                         Mar-88


                                   Mar-90


                                              Mar-92


                                                       Mar-94


                                                                Mar-96


                                                                         Mar-98


                                                                                  Mar-00


                                                                                           Mar-02


                                                                                                    Mar-04


                                                                                                             Mar-06
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          Deflating the credit bubble: mortgage credit
          Long-term investment theme: US Housing market

                      Mortgage            Credit support for           4y Cumulative
                        pool                ABX tranches                   HPA



                                                 AAA


                                                               23.9%
                                                                           -40%
                                                  AA

                                                               14.0%       -20%
                                                  A
                                                               8.6%        +5%
                                                 BBB
                                                               5.6%        +20%
                                                 BBB-
                                                               4.5%

                                                               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%




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          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)
                  •   34%   Banks
                  •   21%   Insurance companies
                  •   15%   Hedge funds
                  •   14%   Securities houses
                  •   16%   Other
Page 23
          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%    34%
                                                                             30%                             30%
           30%
                                                              27%

                                23%
                                                     21%
                                         19%
           20%        18%

                                                                                             14%     14%


           10%




            0%
                    1993      1994      1995        1996    1997     1998   1999   2000    2001     2002    2003   2004   2005   2006   2007


          Source: E. Altman, NYU Salomon C enter
Page 24
          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):
              •   ABS, corporate debt, equity long/short
              •   Emerging markets sovereign debt
              •   European sovereign debt
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          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




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          Theta Capital Management
          Contact Details


          Theta Capital Management B.V.
          Johannes Vermeerstraat 9
          1071 DK Amsterdam
          The Netherlands

          Telephone:        +31 (0) 20 5722733
          Fax:              +31 (0) 20 5722744
          E-mail:           info@thetacapital.com
          Website:          www.thetacapital.com




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