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The Hedgeweek Interview: Bryce Markus, portfolio manager and managing principal, BlueMountain Capital Management: "The credit crunch of summer 2007 has not yet played itself out"

Bryce Markus, a managing principal at BlueMountain Capital Management, argues that many of the problems affecting credit markets, including the housing crisis, institutions' mistrust of the rating agencies and losses built into banks' balance sheets, have still to be resolved.

HW: What is the background to BlueMountain?

BM: BlueMountain was established in 2003 by three of my colleagues, Andrew Feldstein, Gery Sampere and Stephen Siderow. We set out to build an institutional asset management firm focused on the global liquid credit markets, bringing to bear our experience at JP Morgan and Goldman Sachs and our grounding in credit research, quantitative methods and structured products.

Today we manage USD4.5bn across eight different absolute return funds and USD1.4 billion across three collateralised loan obligations. Our flagship Credit Alternatives Fund is a multi-strategy credit fund with a market-neutral relative value approach. In Credit Alternatives, we trade a range of credit-oriented strategies, including long/short credit, capital structure, curve and basis trades, index arbitrage, structured credit, ABS and volatility. We also have funds dedicated exclusively to structured credit (BlueCorr) and equity volatility (Equity Alternatives).

HW: Who are your service providers?

BM: We use Ernst & Young as our accounting firm, Purrington Moody Weill as our US law firm and Maples and Calder as offshore law firm, GlobeOp Financial Services as fund administrator, and several prime brokers, including Goldman Sachs, Morgan Stanley and Deutsche Bank, all for derivatives prime brokerage.

HW: How and where do you distribute the fund? What is the profile of your current and targeted client base?

BM: Access to BlueMountain's funds is arranged on a one-on-one basis. Our client base is mostly institutional and highly diversified, including fund of funds, public and corporate pension funds, university endowments, insurance companies, banks, family offices and high net worth individuals. Most of our assets are from North America and Europe, but we have significant investors in Asia, the Middle East and Latin America as well.

HW: What is the investment process of your fund?

BM: Our 'edge' is the way we combine fundamental company and sector research with quantitative analysis and a technical understanding of the market. Our 18-person credit research team analyses companies from the bottom up and makes relative value recommendations to portfolio managers, who then combine this fundamental view with an assessment of the supply/demand pressures in the market and overlay rigorous quantitative analysis. Because we have separate credit research, quantitative strategy and trade execution teams, portfolio managers can focus full-time on developing investment themes and managing risk.

HW: How do you generate ideas for your fund?

BM: Ideas may come from several different areas at BlueMountain, but each idea inevitably receives the benefit of being 'pressure tested' by all functional groups. For example, an idea may be generated by a credit analyst who expresses a fundamental view that Company X's credit trades cheaply relative to Company Y's.

Our portfolio managers will subject the idea to their scrutiny, our quantitative analysts will run the idea through statistical analyses and models, and our traders will evaluate the viability of executing the idea and the risk of 'technical damage' to the proposed trade.

Conversely, an idea may be generated by our quantitative strategy group, where a model may identify a dislocation in pricing of a certain instruments. Again, the idea will be run by all the other groups, including fundamental research. Portfolio managers will weigh the input from each group in determining whether and how to initiate a risk position.

HW: What is your approach to managing risk?

BM: Our risk management approach is multi-pronged. First and foremost, we invest heavily in our risk analytics infrastructure. Because BlueMountain trades heavily in OTC derivatives, we made the early decision to develop a proprietary software platform and invest in a state-of-the-art risk management and operations team. Today, a global team of risk professionals produces a detailed daily risk report based on real-time mark-to-market of our book. Several groups are involved in risk management at BlueMountain.

Our risk management team, which is housed separately from our investment professionals in our mid-office, generates risk analytics and monitors risk levels and limits. We have a set of sophisticated limits and stress test on the portfolio and single name level.

In addition, our credit analysts 'own the names' and are responsible for appropriate net exposure to each name across our strategies. Our portfolio managers 'own the positions' and are responsible for risk levels in each strategy. We review and adjust risk daily, and conduct formal risk meetings weekly.

HW: Has your performance been as per budget and expectations? Do you expect your performance or style to change going forward?

BM: Our style and approach has not changed but the number of strategies and markets in which we operate has grown and evolved.

HW: What opportunities are you looking at right now?

BM: For our current set of strategies, we see very attractive risk/return opportunities at the moment. The summer's volatility has created dislocations that we are well positioned to exploit. Structured credit and index arbitrage strategies are examples of credit-oriented trades where we have a unique edge and are excited about the coming six to 12 months in particular. We are heavily involved in the bank loan market, trading both cash loans and synthetics in relative value format.

Many others are looking at this market, but few have the resources and committed funding it takes to capitalise on it. We have also done very well trading in equity volatility, and are actively growing this set of trades as we are seeing a compelling set of opportunities in this market.

HW: What events do you expect to see in your sector in the year ahead?
BM: We believe that the credit crunch of summer 2007 has not played itself out yet. We expect higher levels of volatility across asset classes, particularly in credit and structured credit, through at least the next two quarters.

Many of the problems affecting credit markets are not solved, from the continuing crisis in housing to institutional investors' deep mistrust of the rating agencies to the losses built into banks' balance sheets. All these factors may well spill over into a fundamental, macro-economic downturn and higher default rates, although I wouldn't bet on this scenario in the next 12 months.

HW: How will these developments impact on your own portfolio?

BM: We are defensively positioned in the current environment. On a fundamental level, we are long defensive sectors like utilities and telecoms, and short cyclical sectors like homebuilders, chemicals, and pulp and paper. On a micro level, we are long higher-quality names and the upper parts of capital structures versus short deteriorating names and lower parts of capital structures.

While we run our funds market-neutral, we like to buy optionality to a market sell-off or, in other words, get long systemic volatility through our correlation and index arbitrage strategies. We expect that this type of positioning will work well over the coming quarters.

HW: What differentiates you from other managers in your sector?

BM: Several elements make BlueMountain different: the integration of several disciplines -fundamental, quantitative and technical analysis - into one coherent trade idea, the pedigree of our team, our size and strong relationships with the street, the operational and risk management infrastructure, and our focus on stratified yet liquid markets with significant structural alpha.

Lastly, our principals were among the founding fathers' of the credit derivatives markets in the 1990s and have seen these markets grow up and go through several cycles. We continue to innovate and push the boundaries on this front, which helps us identify the next trading opportunity.

HW: Do you have any plans for other product launches in the near future?

BM: We recently launched two special situations funds, one focused on structured credit and the other on bank loans, both of which are hard-closed. We will evaluate the market opportunity and may launch further such funds in the future.

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