Bloomberg News

Crisis Playbook Limits Debt Swap Recovery, Prosiris’s Ali Says

November 09, 2011

Nov. 9 (Bloomberg) -- Credit-default swaps are underperforming stocks partly because Wall Street is borrowing from “playbooks” created during the 2008 financial crisis to protect against Europe’s fiscal imbalances sparking a market meltdown, said Reza Ali, head of hedge fund Prosiris Capital Management LLC.

The Standard & Poor’s 500 Index yesterday trimmed losses since the end of July to 1.3 percent, after the measure tumbled as much as 14.9 percent. A default-swap index tied to U.S. high- yield company bonds was down 3.9 percent over the same period, following an 11.5 percent plunge, according to data provider CMA. A benchmark tied to top-ranked commercial mortgage securities dropped 2.9 percent, after falling 7.5 percent.

“Starting in the first week of August, and nearly every week after that, we’ve asked ourselves the fundamental question of, ‘If a Lehman-like event were to happen tomorrow, have we protected our portfolio?’” New York-based Ali, a proprietary trader at Goldman Sachs Group Inc. through 2009, said yesterday.

Investors and dealers have learned to hedge against “tail- risks,” such as the credit freeze following Lehman Brothers Holdings Inc.’s collapse, by wagering against bonds trading near face value or credit-swap indexes priced close to par, he said. That’s because the swaps offer “asymmetric” returns without much “downside,” he said in a telephone interview. Credit- market investments typically don’t climb much above 100 cents on the dollar.

Tail risk refers to the outlying points, or tails, on bell- shaped curves that forecasters use to plot the probability of losses or gains in a given market. Credit swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt.

Berlusconi Offers

Italian five-year bond yields rose above 7 percent today for the first time in the euro era as LCH Clearnet SA raised charges on clients for trading the debt. The country’s Prime Minister Silvio Berlusconi yesterday offered to resign and Greek Prime Minister George Papandreou’s talks on forming an interim government dragged into a third day.

Prosiris, which received initial capital from Bahrain-based Investcorp and manages about $150 million, gained an estimated 6.2 percent through October after beginning to invest in July, according to an investor letter. Ali was a head of an Americas principal funding and investments group at Goldman Sachs, working there from 2006 to 2009, according to a May statement.

The hedge fund uses several types of swaps as hedges for holdings, which include equity tranches of collateralized loan obligations, enhanced equipment trust certificates backed by airplanes and “seasoned” mezzanine slices of commercial- mortgage bonds, he said.

Invested in Cash

Ali is also about 40 percent invested in cash because he’s learned “what you’re supposed to do is increase your liquidity decrease your risk, and put on hedges to cover tail risk. Interestingly enough, I think that’s what a lot of dealers did as well as they started to de-risk” in August, he said.

Some investors are buying protection through default swaps on everything from U.S. property debt to Russian bonds, because of the possibility that China will curb growth or Ireland’s debt problem may return and damage markets, Ali said.

“There’s too many things that can happen for you to feel comfortable just being long without any protection,” he said.

--Editors: Pierre Paulden, John Parry

To contact the reporters on this story: Jody Shenn in New York at;

To contact the editor responsible for this story: Alan Goldstein at

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