Alec Litowitz and Ross Laser founded Magnetar Capital in 2005. Litowitz used to work for Ken Griffin’s Citadel Investment Group and Ross Laser was with Glenwood Capital Partners. Magnetar had around $8 Billion under management in 2007 and returned 26%. Litowitz made close to $300 Million in 2007.
Magnetar had a bad reputation in the media and Wall Street. To tell the truth, both the media and Wall Street severely underestimated Magnetar. “If you’ve been playing poker for half an hour and you still don’t know who the patsy is, you’re the patsy,”Warren Buffett once said. The media and Wall Street banks thought that Magnetar Capital was the patsy and would lose its customers’ billions. Wanna know what they did? They kept playing poker with Magnetar.
In 2005 and 2006 most Wall Street firms knew the top slice of CDOs were the riskiest, and they couldn’t find anyone to buy them. They thought real estate prices wouldn’t decline and if real estate prices did decline, the top slice of the CDOs would probably be wiped out but the rest of the CDOs would be safe to invest in. So, they were more than happy to sell the riskiest stuff to Magnetar. We’re pretty sure they were calling Magnetar “the idiots”.
Alec Litowitz wasn’t as stupid as the banks thought. The riskiest tranches also had the highest yield, sometimes yielding as high as 20%. So Magnetar used the cash flow from the potentially toxic waste that banks dumped on them to buy insurance on the CDOs. Surprisingly, insurance was extremely cheap, so they spent some of the cash flow to buy insurance to hedge all of their exposure and then some. They were still making money though. If real estate prices didn’t collapse, they would make money. If real estate prices did collapse, they would make more. This is what a hedge fund is supposed to do. Hedge. Whatever the outcome, they should come out ahead. We call that alpha.
On the other hand, Wall Street banks lied and tried to fill their pockets at the expense of innocent people. The events revealed that Wall Street banks were the patsies on the poker table, not Magnetar. Unfortunately for the taxpayers, Wall Street bankers didn’t pay the price, they were bailed out. We don’t think it’s fair to blame Magnetar for the CDO fiasco. SEC agrees with us. That’s why they made JPM pay $154 Million to settle the charges that they misled investors.