Before we start, a little history lesson...
At the beginning of 1998, Long-Term Capital Managementhad equity of $4.72 billion and had borrowed over $124.5 billion with assets of around $129 billion, for a debt-to-equity ratio of over 25 to 1.
It was run by finance veterans, PhDs, professors, and two Nobel Prize winners. Everyone on Wall Street wanted a piece of their profits.
But by 1998, that firm was primed to expose America's largest banks to more than $1 trillion in default risks. The demise of the firm, LTCM, was swift and sudden. In less than one year, LTCM had lost $4.4 billion of its $4.7 billion in capital.
The disaster had all the players - the Federal Reserve, which finally stepped in and organized a bailout, and all the major banks that did the heavy lifting: Bear Stearns, Salomon Smith Barney, Bankers Trust, J.P. Morgan, Lehman Brothers, Chase Manhattan, Merrill Lynch, Morgan Stanley, and Goldman Sachs.
In desperate need of a $4 billion bailout, the crumbling firm was at the mercy of the banks it had once snubbed and manipulated.
And so, given all that, we would imagine lessons were learned, 'risks' were comprehended, and the fallacy of so-called experts (or as Taleb would call them Intellectual-Yet-Idiots) once and for all distinguished.
Which brings us to today... Meet Morten Mathiesen, 45, chief investment adviser at Copenhagen-based Moma Advisors A/S, whose Asgard Fixed Income Fund has delivered a 19 percent return in the past year.
As Bloomberg reports, the philosophy behind his success - the best returns are not in the riskiest stocks but in the least risky bonds. But you can’t get them without leverage.
“That’s the core of our strategy,” said in a phone interview on Thursday. “The best risk-adjusted returns are actually the low vol trades.”
“We try not to speculate whether rates will go up or down,” he said. “We’re typically fully hedged.”
Bloomberg reports that Mathiesen uses a proprietary model to forecast and pick the best risk premiums in short-term, high-quality bond markets. Most of the fund’s bonds are AAA rated, such as Danish mortgage bonds.
“We’re long risk premiums in fixed income,” he said. “We have a strong bias toward the Nordics. We invest in anything that has a risk premium that doesn’t involve credit risk.”
The 600 million-euro ($670 million) fund bets on yield spreads, country spreads and money market spreads in the European fixed income markets.
The spread is usually small so the fund must borrow money to boost the return. Current leverage is about 11 times and has been as high as 25 times, according to Mathiesen. The volatility target is about 6 percent.
As Mathiesen concludes...
“We’ve been successful in providing alpha,” or excess returns, he said. “We’ve produced a higher risk-adjusted return than what the carry should justify in the positions we hold.”
By 'alpha' we suspect Mathiesen means massively-levered beta, but still, performance has been stellar... The fund has delivered returns of 14 percent a year since its inception in 2003 and is beating key bond indexes. Bloomberg’s government bond index has returned 5 percent per year over the past decade.
However, looking back we are getting an ugly sense of deja vu all over again.
"Almost unbelievable track record" - check
"Sophisticated proprietary model" - check
"Betting on small spreads with borrowed money" - check
"25x leverage" - check
"we're fully hedged" - check
What could possibly go wrong?