NEW YORK (Dow Jones)--Rockwater Hedge LLC's making a bet on municipal bonds.
The lure was irresistible, according to Bryan Williams, managing principal of the
Newport Beach, Calif.-based fund comprised of hedge funds. Just last year, Williams
morphed from being a conventional advisor of high-net-worth individuals into being a
hedge fund manager.
"Never in 25 years in the money-management business had I come across such a timely
and compelling strategy," says Williams who picked municipal bond arbitrage out of a
smorgasbord of hedge-fund strategies because of its potential for persistently high
returns.
"Investors need an alternative. The bull retail in bonds is finishing, there are single-digit
expectations for equities, and there's a load of money in cash," Williams says.
Not generally regarded as exciting investments, the $2 trillion municipal bond market
has been traditionally dominated by individual holders - either through direct investment
or via mutual funds - who comprise 70% of the municipal bond market.
Over the last four to five years, and increasingly over the last two years, however, savvy
hedge funds have been moving into municipal bonds looking for returns that have
become more difficult to find elsewhere.
Rockwater invests its clients' money in some of the 25 individual hedge funds which,
Williams believes, comprise the total number of funds dedicated to municipal bond
arbitrage out of about 8,600 hedge funds and funds of hedge funds, according to data
from Chicago-based Hedge Fund Research.
Money is made by splitting a long-term, triple-A-rated municipal bond into two
certificates: a floating-rate short-term instrument the fund sells to money-market retail
investors and on which it pays 3% interest, and a residual long-term piece which the
fund retains. Leverage is created by issuing more floating-rate certificates than residual
certificates.
The fund also shorts top-quality corporate bonds to hedge against the risk of interest
rates going up on its long-term piece of the municipal bond.
Dow Jones Tip Sheet: Rockwater Hedge Reckons Municipal Bonds Are Hot-1
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