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How Brevan Howard profited from the ‘London Whale’

Rogue trader Bruno Iksil, aka the ‘London Whale’, created relative value trade opportunities between different indices, which Brevan Howard was able to exploit.

 
How Brevan Howard profited from the ‘London Whale’

Brevan Howard has reduced the risk profile of its closed-ended BH Credit Catalysts fund, and says JP Morgan’s scaling back of its proprietary bond trading has reduced both liquidity and opportunities in the market.

The investment bank has reduced the amount of proprietary capital it is willing to trade since the so-called ‘London Whale’ rogue trader Bruno Iksil’s credit default swap trades incurred losses that could yet rise to $7 billion (£4.5 billion).

Although the size of JP Morgan’s trades were not too big for its capital base, they dwarfed the liquidity of the market, meaning it was unable to exit certain positions quickly. This led to relative value trade opportunities between different indices that BH Credit Catalysts was able to exploit, by buying tranches of corporate credit.

Pricing anomalies

‘They are known to be very large players in the index tranche market and this must have created interesting pricing anomalies,’ said an investor in the BH Credit Catalysts Master fund.

Charlotte Valeur Adu, chairwoman of the London-listed investment trust, said: ‘The Credit Catalysts Master fund did a lot of relative value trading in the first five months of the year and it has been one of the fund’s two most profitable strategies so far.’

The trust’s other successful strategy has been buying and holding residential mortgage-backed securities (RMBS). Although the closed-end fund was only launched in December 2010, the underlying Brevan Howard Credit Catalysts Master fund has been running for over seven years and first started building positions in RMBS between 2005 and 2007.

Valeur Adu said securities currently trading in the region of 25¢-30¢ on the dollar would still pay out around 40¢-50¢, even in the likely event of a default.

‘Investors are attracted to the higher “carry” of many RMBS and added to this is the protection provided by low security prices,’ the company noted in a recent statement.

‘We believe that the Fed will actively consider increased accommodation, and we remain of the view that if such accommodation includes further asset purchases, there is a strong chance the Fed will revert to the direct housing transmission mechanism of buying agency RMBS. This would provide additional support for housing, at least for those who qualify for agency mortgages.’

Mortgage affordability has improved markedly over the past two years, with the National Association of Realtors’ Housing Affordability index reaching its highest level since its inception in May. But the greatest driver is likely to be when the litigation around Ambac is settled.

The bond insurer stopped paying out on claims over a year ago and remains embroiled in a number of law suits against investment banks over the quality of the mortgage books it was sold and then used as security on bonds it insured.

A proposed $8.5 billion Bank of America rescue plan announced last year has since been held up in the courts.

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