Cleaning Up on the Meltdown

[EV_Ares]

By anticipating problems in the credit markets, a Yale-trained computer scientist and other asset managers are producing healthy returns
by Steve Rosenbush

Back in the fall of 2006, hedge fund manager Nandu Narayanan was thunderstruck by a relatively obscure economic metric, the ratio of credit to a country's gross domestic product. Back during the Asian economic crisis of the late 1990s, Malaysia's ratio was an astonishing 220%, or $2.20 in debt for every dollar of economic output. Yet as 2006 drew to a close, the ratio in the U.S. climbed to an eye-popping 370% to 440%, depending upon how it was measured. "To say that it was well north of anything ever seen in most countries of the world is a fact," Narayanan says. "Any rate rise in the U.S. was likely to cause big problems in the credit space." Thus, he deployed his assets to capitalize on this early warning sign of the looming meltdown in the U.S. credit market.

It was just the sort of big-picture thesis that managers of so-called macro funds seek. Narayanan was a disciple of some of the pioneers of macro funds. A Yale-trained computer scientist, he earned a PhD and an MBA at Massachusetts Institute of Technology's Sloan School of Management, where he studied with Paul Krugman, the prominent economist and New York Times columnist. His academic background had honed his ability to synthesize big ideas from reams of data. Narayanan had put those skills to practice by working for billionaire macro fund managers Julian Robertson, founder of hedge fund Tiger Management, and Bruce Kovner, founder of hedge fund Caxton Associates.

Opportunity in a Reversal
Narayanan had since founded his own fledging macro fund, the $100 million Trident Investment Management. Convinced that even a modest rise in interest rates would trigger a major downturn in the credit markets, Narayanan bet that the value of subprime mortgages traded in the financial markets would fall. He accomplished that by buying insurance polices on debt issued by subprime lenders and mortgage insurers. As the lenders and mortgage insurers were hit by rising default rates, the value of the insurance policies rose. He also employed the same strategy in the mortgage insurance market.

Now his fund is up 25% for the year as of the end of July, the last officially reported number. Through Aug. 24, Trident has returned 35% in 2007.

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