Bill Ackman, Bruce Berkowitz, and other investors who are long on Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) have gotten most of the attention as GSE reform has become a bigger part of the news cycle, but after a year of rising share prices, in the face of a government promise that dividends will never be paid, those positions also looked like good targets for short sellers.

Fannie Mae Freddie Mac FHFA Federal National Mortgage Assctn Fnni Me (FNMA)

After taking a beating from shorting Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA), Waterstone Capital Management used the recent dip in price to cut its losses and reduce exposure to what is becoming a difficult-to -predict political risk. Waterstone’s Fannie Mae short lost 2.5% in February, according to its recent letter to investors.

“This loss has been made back in March, but we have reduced the size of this position in March because of the extreme volatility and rampant speculation in these securities,” the fund wrote in a recent letter to investors, a copy of which was reduced by ValueWalk. Fannie Mae preferred shares (FED NTL MTG SER Q (OTCBB:FNMAI)) have fallen from a high of $11.40 on March 7 to $8.79, compared to less than $3 a year ago; common shares are down from a recent high of $5.82 to $4.03, but still up 350% over the last 52 weeks.

The Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) short was Waterstone’s biggest loser in February by a fair margin (the next largest was New Albertsons (NEWALB), down 0.74%), and was also their worst position in January, losing 0.61% compared to State Bank’s (STBZ) drop of 0.26%. The Waterstone Market Neutral Master Fund was down 8.03% in February after gaining 8.57% in January, putting it slightly negative for the year.

Waterstone has previously backed away from ‘ridiculous’ Fannie Mae

This isn’t the first time the fund has decided to step back from its short position, Waterstone has been shorting Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) for the better part of a year, and at one point it was the fund’s largest position. Last summer Waterstone also reduced its short position to focus on short term bets to better exploit the stock’s volatility, calling the trading “ridiculous, irrational, and extremely speculative.”

With the executive and legislative branches basically guaranteeing that the shares had no value, it looked like a good bet at the time, which is why they weren’t the only investors to get caught by rising prices. Short interest started dwindling in January, and anyone looking to take a position now has to resign themselves to a long, drawn out court battle. Waterstone hasn’t wavered from its belief that Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) shares are actual zeroes, but it’s less interested in sticking around to find out.

Waterstone’s top performers

Waterstone’s best performing stocks in February were Talmer Bancorp Inc (NASDAQ:TLMR) which gained 1.43%, Chesapeake Energy Corporation (NYSE:CHK)/Devon Energy Corp (NYSE:DVN) which was up 0.73%, Clear Channel Outdoor Holdings, Inc. (NYSE:CCO) which was up 0.48%, and Dendreon Corporation (NASDAQ:DNDN) which was up 0.19%. Talmer was one of the fund’s biggest detractors in January, losing 0.26%.