Institutional Investor's Alpha Magazine - December 2007/January 2008 - (Page 12)

UPDATE Mohnish Pabrai W hen Mohnish Pabrai increased notes, which he soon after converted his bet on Delta Financial Corp. into 2 million shares at $5 each, while last summer, taking part in a $70 million Angelo Gordon purchased $60 million bailout of the troubled mortgage lender, in warrants. But the emergency cash infusion he did so thinking that Delta had a ﬂoor. “The mark-to-market value of its as- only prolonged the inevitable. In Nosets exceeded its stock price, and it vember, Delta fired most of its 1,395 had an earnings engine,” says Pabrai, a value investor who Mohnish has fashioned himself after Pabrai: Berkshire Hathaway chairSmiling man and CEO Warren Buffett. despite Unfortunately for Pabrai, in subprime December the lender crashed returns through its ﬂoor. Alpha f ir s t chronicled Pabrai’s investment in Delta last fall (“The Oracle of Irvine,” October 2007). At the time, it remained uncertain how his 28 percent ownership of the Woodbury, New York– based lender would play out. Pabrai had already stepped up once to defend his position — which at more than 4.6 million shares of Delta represented roughly 10 percent of his portfolio — as the subprime crisis employees; the following month it ﬁled took its toll on the company. In August, for bankruptcy. Pabrai sold the bulk of instead of dumping his stake in Delta his shares for 26 cents or less, amountwhen its shares fell to $5 — close to ing to a loss of roughly $50 million. Pabrai had believed that Delta half what he’d paid — Pabrai joined New York–based hedge fund ﬁ rm An- would be able to escape the carnage gelo, Gordon & Co., Delta’s second- because it made only fixed-rate sublargest shareholder, in a rescue effort. prime loans. It didn’t offer adjustablePabrai bought $10 million in convertible rate products, which triggered most of 2007’s delinquencies and foreclosures by its competitors. But investors made little distinction. When the market for repackaged subprime home mortgages disappeared, so too did investors willing to buy Delta’s loans. Pabrai says the shutdown of the subprime mor tgage market was totally irrational and that it was a logical assumption to think it would return. “It made per fect sense for me to make that bet,” says Pabrai. “The odds were overwhelming that I would beat the dealer.” He adds that any stock has the potential to fall to zero. “The market is a game of probabilities,” he explains. “ We make bet s when the odds are in our favor.” Pabrai would not give specifics about his overall 2007 performance but says losses in Delta had little impact on his portfolio and that he has received only two e-mails from worried clients — a group comprising mostly relatives, friends and business associates. According to regulatory ﬁlings for his Irvine, California– based Pabrai Investment Funds, which manages one domestic and two offshore hedge funds, the ﬁrm’s assets declined 3.5 percent from $469 million in 2007’s second quarter to $453 million in the third quarter. — Jaye Scholl Amaranth’s founder, told investors in a letter. The drama, Amaranth alleges, reached the very top of the executive suite at JPMorgan. After an August 29, 2006, surge in the price of natural-gas derivatives wiped out hundreds of millions of dollars in gains, Amaranth’s traders were convinced their positions had been leaked. Within weeks the fund was bleeding billions — losses so severe Amaranth knew the only way it could keep meeting margin calls would be to ﬁnd someone to assume the risk of its derivatives positions. Salvation emerged in the form of a deal with Goldman, Sachs & Co., which took over the portfolio in return for a $1.85 billion concession payment from Amaranth. But JPMorgan, which had set its own sights on Amaranth’s portfolio, according to the complaint, refused to execute the trade — claiming the deal would have opened the broker to more risk. When Amaranth arranged an identical deal with Chicago -based Citadel Investment Group, JPMorgan again quashed the agreement — this time by allegedly telling Citadel founder Kenneth Grifﬁn, “Amaranth is not as solvent as they are telling you.” Following the second lost trade, Jamie Dimon, JPMorgan’s CEO, informed Amaranth that his ﬁrm had arranged a new trade whereby it would assume the struggling portfolio itself and would engage in its own trade with Citadel, which would pay $725 million to JPMorgan directly. “The allegations are incredible,” says Lamar (Mickey) Mixson, a partner at Atlanta law ﬁrm Bondurant, Mixson & Elmore who has represented individuals and corporations in a wide variety of business disputes for more than 25 years. “It doesn’t sound like your typical broker– hedge fund relationship.” JPMorgan decries the suit as an effort by Amaranth to rewrite history and blame the prime broker for losses from its own disastrous trading, noting that it will ﬁght the case vehemently. “JPMorgan’s conduct was entirely Photo by Ben Clark for Alpha 12 • INSTITUTIONAL INVESTOR’S ALPHA • DECEMBER 2007/JANUARY 2008

Table of Contents Feed for the Digital Edition of Institutional Investor's Alpha Magazine - December 2007/January 2008

Institutional Investor's Alpha Magazine - December 2007/January 2008 Contents Letter from the Editor Longs & Shorts Pension Corner: Liberal Returns The Good Guy: Inner-city MVP Cover Story: Marathon Men Interview: Rizk Management Profile: Living on Hostile Ground Profile: Buy and Hold In Theory: The Fallacy of Portable Alpha Strategies: Changing Course Alpha Bytes: Behind the Scenes Unhedged: Commentary: An Activist Alternative

Institutional Investor's Alpha Magazine - December 2007/January 2008

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