Institutional Investor's Alpha Magazine - May 2008 - (Page 36)

Boaz Weinstein derivatives were convertible-arbitrage hedge funds like Citadel (which has since expanded to become a multistrategy ﬁrm). These managers turned to credit default swaps — the most common form of ﬁ xed-income derivative, which allows investors to take out insurance against defaults — to hedge their bond exposure. Today, Weinstein oversees 700 traders across the debt spectrum. He also runs Saba Capital, a Deutsche proprietary trading group. The 40-person Saba team specializes in a unique type of capital structure arbitrage that Weinstein helped pioneer. Early this decade, Weinstein began to study the relationship between credit, equity and volatility and how to proﬁt from inefﬁciencies among the three. Rather than limit his capital structure arbitrage research to distressed bonds and equity, — KENNETH GRIFFIN, CEO, he added a wrinkle by includCITADEL INVESTMENT GROUP ing credit default swaps and equity derivatives. The result, an innovation that has drawn accolades from hedge fund managers, was like putting traditional capital structure arbitrage on steroids. “The ﬁnancial community is still in the early days of recognizing the value of the relationship between the two markets,” says James Delaney, a former head of capital structure arbitrage at credit derivatives broker-dealer GFI Securities in New York who is launching his own hedge fund. “Boaz is one of the pioneers.” It’s not surprising to learn that Weinstein is a master chess player — his immigrant parents enrolled him in a chess workshop at the tender age of ﬁve. A product of New York City’s Stuyvesant High School and a graduate of the University of Michigan, where he majored in philosophy, Weinstein also has a fondness for casino card games. “Poker and blackjack are good training,” he says. “If you look at a professional poker player, maybe 70 percent of the hands that they are dealt they immediately fold. With poker, the evening comes down to four or ﬁ ve important hands. And at a hedge fund, or a prop group at a bank, often the year comes down to four or ﬁve important trades.” Last year the important trade was subprime. How funds played the subprime market proved to be a makeor-break decision for many. But new hands are always being dealt. Now, Weinstein says, many sub-investmentgrade corporate bonds have been falsely tainted by the credit crisis, and therein lies opportunity. Weinstein recently met with Alpha Staff Writer Imogen Rose-Smith at Deutsche Bank’s Wall Street ofﬁces to discuss last year’s meltdown and how hedge funds can make money in the credit market now. Alpha: What triggered the corporate credit market meltdown? Weinstein: The starting point was last June and July, “Boaz Weinstein is on the short list of people I call to discuss market opportunities.” because that is when the leveraged-buyout machine shut down over an inability to place high-yield bonds and loans into the market. People were concerned about the $350 billion pipeline of debt that banks were on the hook for and the shuttering of the collateralized loan obligations market because of subprime losses. As a result, high-yield spreads, which started the summer too tight, blew out. But what is interesting is it only affected the high-yield and loan markets; the equity market did not fall. And there was this incorrect notion in the markets in July and into August of decoupling. That was the disconnect that started to concern you last June? Even within credit there were serious dislocations, as the secured-loan index, the LCDX, fell as many points as the unsecured high-yield bond index. At their low both indexes were implying a default rate more consistent with a severe recession or depression, while stocks had barely budged, which is just mind-boggling. Why? I could understand credit falling a few points without a corresponding move in equities, but to have a ten-point drop in the most secure part of the capital structure made no sense from a medium-term perspective. Didn’t this notion that problems were isolated also occur in the mortgage market with subprime? Yes. This idea of decoupled markets started in subprime. When subprime ﬁ rst hit, people thought it would be contained. How were mortgage problems related to the high-yield market? When high yield fell, it did so for a couple of reasons. One was simply that spreads were too tight beforehand. But the other was it fell because of subprime. The subprime CLOs that were doing poorly shut down the rest of the CLO market, and the CLO market was really important for the high-yield market to clear loan and bond risk off bank balance sheets. Sounds like you’re describing a domino effect. Subprime problems created CLO problems, which led to corporate credit problems. And yet this idea of decoupling continued to prevail? There was this view that these problems in credit wouldn’t affect equity and wouldn’t affect the European markets. But what we saw from the fall and winter was the shattering of this myth. From November to March equity and credit fell hard across all markets. 36 • INSTITUTIONAL INVESTOR’S ALPHA • MAY 2008

Table of Contents Feed for the Digital Edition of Institutional Investor's Alpha Magazine - May 2008

Institutional Investor's Alpha Magazine - May 2008 Contents Letter from the Editor Longs & Shorts Pension Corner: Send in the Clones The Good Guys: Outside the Box Cover Story: Welcome to Oz Interview: The Tipping Point Regulation: When Sentinels Go Astray Strategies: Taking Credit Research Center: The Hedge Fund 100 Book Excerpt: Shoot the Messenger Alpha Bytes: VaR Enough? Unhedged: Commentary: Not Your Father's Activist

Institutional Investor's Alpha Magazine - May 2008

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