Commonwealth Opportunity Capital

Global macro with a focus on European sovereign debt

BILL McINTOSH

There are several unusual things about CommonwealthOpportunity Capital. For a start, it is based in Los Angeles and while the city is obviously an important financial and business centre, hedge funds are relatively thin on the ground.

What’s more, the firm’s co-founders, Adam Fisher and Reagan Silber, chief investment officer and president respectively, are both successful entrepreneurs. Fisher invested in US and Asian real estate with backing from DE Shaw & Co., while Silber had success in law, telecoms and real estate.

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Also unusual, perhaps, is that a Los Angeles-based global macro fund is focusing most of its investment attention on Europe. In a somewhat contrarian move, Commonwealth has around three-quarters of its capital invested in euro denominated sovereign debt from Germany, the Netherlands, Italy and Spain.

Opportunistic and discerning
“It is a very broad canvas,” says Fisher, discussing the firm’s discretionary macro strategy. “We are quite opportunistic and we are quite discerning. We don’t like to deploy capital unless we think something is unusual or interesting.”

Fisher and Silber launched the Commonwealth Opportunity Master Fund in 2008 with $18 million in day one capital. It is now thought to be managing over $300 million. Aside from real estate, Fisher has also worked in private equity and traded with a risk arbitrage firm affiliated with Reservoir Capital in New York. His trading strategies tend to focus on rates and credit instruments.

Euro zone dislocations
The dislocation and daily shifts in the euro zone occupy most of Fisher’s attention right now. “It is not the only opportunity, but the mix of monetary and fiscal policy choices together with a disjointed political environment tend to create anomalies in those markets,” says Fisher. “This is where the action is.”

With Europe the epicentre of market dislocation, the challenge becomes a question of how to structure the most appealing trades on a risk/reward basis. Here the approach is to find price relationships that are inconsistent.

In Europe, in the middle of 2012, there are a large number of price relationships that may not stand up to scrutiny. This might involve, for example, the relationship of a sovereign debt issue to a credit default swap or, perhaps, a banking stock trading at 30% of book value.

“Europe is self financing,” says Fisher. “The problem is the huge imbalances within Europe. Are the solvent countries willing to help finance the ones which aren’t? There are lots of anomalies right now.”

A European CDO
Fisher’s analogy for the contemporary European government bond market is that it is, in effect, a collateralised debt obligation. This is reflected in the prices of different bonds. Within this euro CDO, at the top of the structure is the risk free tranche, which is German government debt.

At the opposite end is the equity tranche holding, perhaps, government bonds from Ireland or Portugal. Just above is Spain’s sovereign debt, with the Netherlands and Austria higher up still, representing the senior tranche.

“The cash market tells you one thing; the credit default swap market something else,” says Fisher. “The combination is interesting putting aside whether, for example, CDS are banned. Add in bank loans and it becomes even more interesting. Who will be protected and who won’t?”

Commonwealth doesn’t take positions in contradiction to the market. Instead, it looks for positions orthogonal to the market.

Possible default
Take Portugal. CDS prices show the country has a reasonable possibility of defaulting over the next year. It is the same story for years two, three and four.

However, the cash market price for Portuguese government bonds (with the September 2013 bond close to par) implies that it won’t default. Thus the CDS and cash markets are telling a different story.

Taking advantage of this divergence is not as simple as one might think, so Commonwealth got creative. It sold March 2013 CDS at 15 points and bought 10 year protection at 40 points or, viewed another way, bought nine year protection one year forward at 25 points. The portfolio also bought the 30 year bond at 40.

“In all likelihood there will be some resolution of this issue within three years,” says Fisher. “In all likelihood they will have to mutualise all the sovereign debt in Europe. The only hard and fast view I have is that Portugal won’t default in the next nine months. After that I’m agnostic.”

Since 2010, Commonwealth has been very focused on Europe because Fisher believes it has offered the best opportunity set. The strategy, according to investors, is up 8.8% to end-May and made 10.7% in 2011.

Crude oil
Another market that is attracting Fisher’s attention is crude oil. Volatility has been the hallmark of crude oil prices during the past four years. The price per barrel soared to the record $150 level in 2008 before plunging in the wake of the Lehman collapse. It then rallied but has slid again in the second quarter of 2012. Fisher thinks the recent fall – WTI was trading around $78 in late June – makes crude oil a buy. He notes when consumption fell to 82 million barrels per day (from peak consumption of 86 million bpd), contango in the curve occurred, but five year forward oil never fell below $70.

Oil’s resilient price profile is the result of minimal spare production capacity. “When there is less than 2 million bpd of spare capacity it encourages prices to go higher,” says Fisher. With the Dec 2014 light crude oil contract down $17 to $83 in late June, Fisher says: “You probably want to own it.”

He adds: “The cost to extract a commodity, including economic profit, is where a commodity must trade or better. The point about oil is that prices in the forward market now aren’t that credible.”