Paolo Pellegrini, the former analyst with $27.2 billion New York-based hedge fund Paulson & Co, remains one of the interesting, lesser known figures of the credit crisis. At Paulson & Co. he was responsible for helping come up with the trades that resulted in Paulson’s phenomenal run during the near-collapse. Pellegrini left Paulson & Co. last December and started his own firm, PSQR Management.
The fund, which runs a macro strategy, isn’t doing half badly. Through the end of the third quarter in 2009, Pellegrini’s PSQR Master Fund was up 80.84 percent. PSQR’s first investor letter was distributed in October. So what is Pellegrini looking at these days?
The hedge fund manager remains bearish on the U.S. housing market. He points out that the debt service holiday currently being extended to delinquent borrowers and foreclosures in progress temporarily boosts borrowers spending power. This will end and, according to the investor letter, “the inventory of foreclosed homes will hit the market.” Meanwhile solvent homeowners will continue to pay down their debt. Just as the housing credit bubble helped grease the skids for an overall economic boom during the last two decades, continuing woes in the housing market will prove to be a drag on America’s economic recovery.
Like practically everyone else, Pellegrini is negative on the U.S. dollar. “We remain fundamentally skeptical about the ability of the U.S. dollar and of dollar-denominated fixed-income assets to retain their value over time,” he writes.
China, he notes, is the big unknown. What the country does will determine the pace of U.S. recovery. But Pellegrini, possibly wisely, has chosen not to make a bet on what China will do, and when. Instead he is trying to take America’s largest creditor out of the equation.
Pellegrini’s investment thesis, as presented in his October 2009 letter, is this: shorting U.S. mortgage-backed securities (MBS) and the U.S. dollar. “We can’t predict which will go down or which will go down more, but in combination we believe they will go down a lot.” He argues that buying commodities and commodity-related currencies are an effective way to short the U.S. dollar.
This trade is also neutral on China, he says. “If China uses [U.S.] dollars to buy U.S. goods, U.S. inflation goes up and MBS go down. If China used dollars to buy other currencies, MBS – in dollars – may not do as badly, but the U.S. dollar will collapse.”
Will this be the greatest trade ever? Pellegrini seems very confident. The idea is elegant. It makes a good deal of intuitive sense. The commodity/finance play (of which this is a close relative given that the banks were all up to the gills in MBS) went wrong in the summer of 2008 when banks rallied and commodities collapsed (just ask Phil Falcone, CEO of Harbinger Capital Management). The two are not an automatic hedge. It will be a matter of managing the positions and their leverage. And the letter warns that the trade may go against them at times, as shorting the mortgage ABX index did in early 2008 for Paulson & Co. “High returns imply the possibility of large temporary reversals, which dealers may exploit to curtail losing positions against poorly prepared counterparties,” the letter says.
Like Pellegrini, one of the few reporters to document the implications of the looming sub-prime crisis early was Bloomberg News journalist Mark Pittman. Pittman won the Gerald Loeb Award for his work on sub-prime, and has a starring role in the independent documentary film on the crisis, American Casino. Tragically, Pittman won’t be around to help us figure out what happens next. He suffered from heart disease and died in November at age 52. Pittman was a great guy and an incredible journalist. He did things the right way, with passion and guts, never afraid to speak truth to power or ask the tough questions. He believed in fighting for the good guys and going after the bad guys. Pittman, to borrow a phrase from Ernest Hemingway, lived his life “all the way up.” He was an inspiration and will be missed.
The Alpha / Beta blog is devoted to news and insights about the alternative investment (Alpha) and the traditional asset management (Beta) industries. Institutional Investor staff writer Imogen Rose-Smith covers hedge funds, private equity and their investors. Julie Segal is an Institutional Investor staff writer covering money managers and pension funds, foundations and endowments.
