Deer Park Road Management’s SBF Opportunities Fund was up 0.91% for June, ending the second quarter with positive returns in all three months. For the first six months of the year, the fund is up 3.29%. The firm’s STS Master Fund was down 5.57%, ending a bumpy quarter on a down note. Year to date, the fund is down 9.64%. Deer Park Road focuses on mortgage- and asset-backed securities.
In the June letter for the firm’s SBF Opportunities Fund, which was reviewed by ValueWalk, management observed that reactions on Wall Street have been running against logic. The noted that uncertainty abounds amid the trade war between the U.S. and China, with both sides seeming to show signs of wanting to reach an agreement and now Trump appearing to be preparing for a currency war in addition to the trade war.
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Additionally, they point out that a Bank of America Merrill Lynch survey of money managers picked up the most pessimistic sentiment recorded since the 2008 global financial crisis. Equity allocations saw their second biggest drop ever recorded, and cash holdings grew by the most since the debt ceiling crisis in 2011. Although the markets didn't predict a rate cut in June, they are pricing in lower rates for this year. Optimism about Fed easing pushed U.S. stocks close to new record highs, and the 10-year Treasury yield headed down toward 2%. Bond ETF investors sought safe-haven assets while Treasuries and rates volatility climb as the bond market rallied.
"Simultaneously we observed once again the ability of equity traders to merrily ignore everything the world throws at them," they wrote. "Bad news is cheered, and good news makes investors nervous. Welcome to the counterintuitive reactions currently prevailing on Wall Street."
However, they added that the good news is that all the political uncertainty which prevails right now has little influence on the legacy non-agency residential mortgage-backed security market. The rates rally has been good for discount bonds by driving strong repayment speeds. Last month there were 27 deals called, representing almost half of the deals that have been called in the first six months of the year. Deer Park Road was exposed to two of the deals.
"Meanwhile, we learned that reserves that were held back on some of our deals that were called in 2017 are due to be returned to investors," they added. "Bonds that we own which have a factor of zero still have upside!"
The Deer Park Road team believes the risk/ reward of other sectors is "heavily skewed to the risk side," so they still like the U.S. housing market right now as a way to generate yield. Although they aren't looking at the new non-agency deals entering the market right now due to their yields, they expect these deals to become targets at some point "as the quality of the collateral plays out and we have more data to model from."
"We are experiencing what has been called 'the most unlocked bull market in history' but it will likely be the most anticipated bear market ever when it arrives," they added.
In their June letter for the STS Master Fund, Deer Park Road management said June marked a retaliation for the uptick in risk appetite. The fund's positions posted strong gains after credit spread widening in December and May, but those gains reversed in January and June as spreads tightened rapidly due to central bank easing.
"To put this in context, credit spreads on the CDX HY (a core Fund hedge in June) have tightened back to ~325 bps after recently reaching almost 400 bps at the end of May," they explained. "Current levels are now close to the lows observed in the past two-years."
They now see a much smaller risk that spreads will contract meaningfully again.
This article first appeared on ValueWalk Premium