A Tale of Two Hedge Funds: Magnetar and Peloton
Describe in your own words, Peleton's winning strategy in 2006.
Peloton’s winning strategy was effective in 2006 and allowed Peloton Partners to become one of the top hedge funds in the country. Ron Beller, the head of the company bet against the United States housing market. Before the subprime crisis hit the country, and people started to default on their mortgage, Beller was able to earn a healthy return by taking a short position on the housing market. The objective was to invest in the mortgage as the banks were issuing mortgages to a large number of people irrespective of their credit history. The investment in mortgage paid around 80% return in 2007
.Describe in your own words how…show more content… You also need to understand how they were short, and how they were funding their short position).
Magnetar rapidly moved downwards to the securities which they believe were mispriced. They took a long position on the collateralized debt obligations which have the highest risk but have the potential of healthy returns in good times. It was hedged against the less risky layer of the CDO’s or same securities. Although, the risky securities incur losses, hedging against the less risky securities paid more when the market collapsed.
How could Magnetar have lost money? Using information from the rest of the case, describe how you think they came to the conclusion that the risk of losing money was remote. (Hint: Though this is a tough question, the answer has to do with how assets in the CDO are correlated).
The risk of losing money lies in the correlation with the asset. Magnetar could lose money if a high correlation exists which would create non-diversifiable risk. Thus, there is a high likelihood that the senior tranches of CDO’s get impaired. If Magnetar contained securities related to the housing market that is not geographically diverse, then it will have a higher correlation. Thus, the housing