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Hedgie's careful prescription for profiting in the mortgage mess

Bryan Caisse says he sees a lot of chances to turn a buck where others have stumbled.

By Roddy Boyd, writer
November 6, 2008: 2:23 PM ET

(NEW YORK) Fortune -- In a time when closures or panicked liquidations of name-brand hedge funds have become commonplace, the opening of a $1 billion fund trading mortgage-backed securities and other types of credit should attract more than a few raised eyebrows.

After all, it has been bonds backed by mortgages and other real estate assets that set off the credit crisis in the middle of last year, leading to what has become the greatest catastrophe in money management circles since 1929.

And just because bonds in the sector are attractively priced doesn't mean they won't get a whole lot cheaper, as Fortress Investment Group learned when the gilt-edged fund got a black eye putting nearly $1 billion to work scooping up mortgage bonds.

But Bryan Caisse, an 18-year veteran of the mortgage markets, sees a lot of profit potential in what has caused many friends and rivals pain.

Caisse is launching Huxley Capital Management with backing from a United Arab Emirates-based investor. He argues that where others have stumbled is the aggressive use of leverage, improper hedging and failing to reckon with the challenges of liquidity.

"Leverage is a very, very dangerous thing in any market; it can be deadly in a market where liquidity is uncertain," Caisse said.

Distressed mortgage fund launches have been one of the few growth areas in the hedge fund universe. But a raft of problems, from pension and endowment skittishness to continuing credit quality problems in many sub-prime and other mortgage-market sectors, have conspired to drive prices of these bonds ever lower.

Most mortgage-backed securities (especially those guaranteed by Fannie Mae and Freddie Mac) are making their principal and interest payments. But with the collapse of mortgage-trading powerhouses Lehman Brothers and Bear Stearns - and the sharp reduction of credit to dozens of bond hedge funds - tens of billions of dollars of mortgage-backed securities have been sold to meet margin calls.

Not calling the bottom

Caisse told Fortune that unlike Fortress, he isn't calling a bottom in the seemingly never-ending decline of mortgage bond prices.

"That's not what we're up to - we can't call or predict those levels."

Instead, he's singling out certain kinds of Fannie Mae- and Freddie Mac-issued mortgage bonds that are trading at historically low prices, despite their now explicit U.S. government backing. Caisse said with proper hedges and conservative leverage, "There are some unprecedented value opportunities here."

"[The price collapse] in these markets is driven by oversupply from forced selling and lack of capital, not from issues of relative value."

A former weapons officer on nuclear subs, Caisse wound up on Wall Street after a beer-soaked game of pool in a New York bar in 1991 with two executives from Bear Stearns, which led to a job offer in the firm's then-embryonic mortgage department. After seven years selling, and then managing, mortgage bonds for Bear, Caisse joined hedge fund West Side Advisors where he worked until last year.

Caisse's background makes clear he has no problem leaving money on the table when he doesn't like his investment choices.

He left West Side last year after the fund's general partner, Gary Lieberman, another Bear Stearns alumnus and a part-owner of the New Jersey Nets, directed a big push into various credit-sensitive types of mortgage bonds (many of which were not backed by Fannie or Freddie). At the time of Caisse's departure, West Side's bet had proven quite painful, according the The New York Post, with a decline of 25% in certain portfolios. Recent performance results for the fund could not be obtained.

Traditionally, West Side had traded only Fannie and Freddie-backed mortgage paper, specializing in a sub-set of the market where the bonds were broken down into interest-only and principle-only parts. To top of page

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