Narula, 49, has used Fannie and Freddie to build the world’s most successful hedge fund. His Metacapital Mortgage Opportunities Fund, which invests heavily in agency mortgages, returned 37.8 percent in the first 10 months of 2012, putting it at the top of the Bloomberg Markets list of the 100 best-performing hedge funds managing $1 billion or more. That comes on top of a 23.6 percent return in 2011. The Mortgage Opportunities fund is up 520 percent since it started trading in July 2008.
Three of the top five funds in the Bloomberg Markets list invested in mortgage securities, and two of them are run by Pine River Capital Management. Betting on mortgage securities outpaced every other strategy, with an average return of 20.2 percent, against an industry average of just 1.3 percent.
The most profitable fund in the first 10 months of 2012 was Steven A. Cohen’s SAC Capital International, which earned $789.5 million for its managers. In November, the Securities and Exchange Commission notified Cohen’s $14 billion firm, SAC Capital Advisors, that it was considering suing it for civil fraud related to insider trading.
Narula’s edge in 2012 was in reading the tea leaves of Washington policymakers. Toward the end of 2011, government-backed mortgage securities dropped in value as Obama expanded programs to help owners refinance and bonds without insurance fell amid the euro crisis.
Narula took advantage. He later concluded that the Federal Reserve was going to help homeowners and bought bonds ahead of its September announcement that it would buy $40 billion a month of agency — that is, Fannie-, Freddie- and Ginnie Mae-backed — mortgage bonds.
Following the Fed
“To revive the housing market, the Fed has thrown a lot of firepower at agency mortgage-backed securities,” Narula says. “Policymakers have worked hard to let homeowners refinance. They’ve been clear that’s their mission — and you want to be careful going against that mission.”
In addition to his intuition on Washington policy moves, Narula uses mathematical models to calculate how long homeowners will make payments at their current interest rates before refinancing or defaulting. The models predict behavior based on a homeowner’s credit score, address, loan size, loan age and other factors. The algorithms also allow sophisticated investors to hedge against wrong-way bets.
“You want to come up with wagers where if you’re right, you’ll do really well and if you are wrong, you don’t get hurt too badly,” Narula says.