THE sumptuous, Turkish-style low sofas in Peloton’s Soho office provided little comfort to the hedge fund’s founders, Ron Beller and Geoff Grant, last week.
After six sleepless nights spent trying to pull together a rescue deal, the two former Goldman Sachs bankers announced on Thursday night that they had been left with no option but to launch a fire sale of Peloton’s flagship $2 billion (£1 billion) ABS Master Fund to pay off their bank loans.
It was a sudden bump back to earth. Only a month earlier, the same fund had been crowned the “New Fund of the Year” at the Eurohedge industry awards. Peloton’s strategy of betting that US sub-prime mortgages would fall in value had clocked up gains of 87% over 2007.
US-born Beller accepted the award with a rousing message of thanks to his team for convincing him that “the sub-prime emperor had no clothes”.
Now it is Beller who has been stripped naked, losing half of his estimated $80m personal fortune through the fund’s collapse.
He is fast becoming the poster boy for a crisis of confidence that threatens to engulf more of London’s hedge-fund industry.
“These guys had a good reputation,” says one rival credit-fund manager. “If Ron Beller has got into trouble, then anyone can get into trouble.”
Beller and Grant started Peloton in 2005 and quickly built up a profile on the back of their Goldman credentials.
A number of senior partners at Goldman Sachs are rumoured to have ploughed their own money into the fund, with some City sources claiming Michael Sher-wood, Goldman’s most senior man in London, is among them.
Beller’s own personal notoriety also helped. He was one of the victims of Joyti DeLaurey – a secretary at Goldman Sachs, who stole more than £1m from Beller and his wife’s bank account without them noticing.
Beller said he only became aware that something happened after he realised his bank account was “light by £1m or £2m” – which gave the defence lawyers a perfect line of attack.
In the end DeLaurey was sent to jail and Goldman returned all the stolen money to Beller – which helped found the fund.
The force and suddenness with which Peloton has come crashing to earth would shake up even the coolest operators. Friends say that both Beller and Grant are “gobsmacked” by the events of the past few weeks.
Peloton’s name derives from the French word for the main pack in a cycling race. It’s a fitting title. The firm has been riding with a large pack of hedge funds chasing investments in bonds backed by mortgages.
Until the credit crunch began to hit home, the market for mort-gage-backed securities was growing quicker than any other segment of the global capital markets. In the US alone there is now an estimated $10 trillion-worth of these mortgage-backed securities in issue.
It has been growing at an exponential rate. In 1999 there was just £5 billion-worth of UK mortgages sold to investors in the capital markets. By 2006 this had soared to more than £90 billion.
Hundreds of hedge funds have been set up specifically to buy these loans, which appeared to be, quite literally, as safe as houses. Investment banks were falling over themselves to pile into the market.
Once the losses in American sub-prime loans began to emerge a little over a year ago, the whole market turned sour.
The collapsed Peloton fund invested entirely in mortgage-backed securities, bonds created by pooling together home loans taken out all over the world.
Peloton’s strategy was considered a relatively safe one. It would buy only the highest quality, AAA-rated mortgage bonds, where there was little chance of the customer falling behind with payments.
At the same time, Beller and his team were making bets that the poorest-quality sub-prime mortgages would fall in value by short-selling the securities.
The $2 billion or so of equity in the fund was constantly leveraged four or five times over, giving the fund a portfolio of assets worth some $9 billion. The high-quality mortgages in Peloton’s portfolio were used as collateral to back the leveraged positions.
It was its bets on the falling value of sub-prime mortgages that led to huge profits last year.
Until early last month Beller was sitting pretty in his chic London office.
In January the firm celebrated its third anniversary. During this time its flagship Peloton Partners fund returned an annualised 27%. And the partners were prepared to keep betting the ranch on their own success.
The performance fees earned by Beller, Grant and third-in-command David Watson over 2005, 2006 and 2007 were piled back into the fund. Together, they invested $117m in the fund.
Beller was even paying his tax bill with his other sources of income, to avoid removing anything from the fund. They were not alone – 25% of all the money paid to the firm’s staff was ploughed back in.
The ABS fund was at the heart of their success, and its performance was really beginning to get noticed.
But by the start of this year, the strategy started to turn sour.
The bet on sub-prime falling had run most of its course. Worse, the high-quality AAA-rated mortgages the fund had bought were losing value fast.
Fears of recession in the US economy were mounting, coupled with a prospect of a crash in the US housing market.
All mortgage bonds began to plunge in value. With Wall Street’s major banks still writing off bad debts at unprecedented rates, credit committees were looking for excuses to rein back their lending.
“All these types of securities have nose-dived,” said one trader. “It seems to be a combination of the economic news and some technical selling spurred by everything going on in Wall Street.”
In the first few weeks of the year, Beller began to receive twitchy calls from his bankers.
With the value of the assets he held in his portfolio in free fall, the banks were tightening his credit terms. They were also demanding that the fund should put up more collateral to support its positions.
To meet these new terms, Beller began to sell some of the AAA mortgages in his portfolio.
But the calls kept coming, with the financing conditions getting ever tighter. And all the time, the value of the portfolio was diving.
The spreads on Peloton’s portfolio are estimated to have doubled over January, then doubled again in the first two weeks of February.
Every time the spreads widened, Peloton had to put more cash with its prime brokers.
Goldman Sachs, Bear Stearns, Deutsche Bank, UBS, Merrill Lynch, Morgan Stanley and Leh-man Brothers were among those with lending lines into the firm. They were getting increasingly nervous about the positions.
Word got out that Peloton was selling assets at distressed prices. That pushed prices lower still, prompting more nervous phone calls from the banks.
Last weekend, there were a number of Peloton’s short-term credit lines falling due, including one from UBS.
Beller and Grant got everyone together to a meeting in London. Some of the biggest creditors to the fund were willing to strike a deal. They volunteered to subordinate themselves in a restructuring deal, agreeing to wait until everyone else got paid before taking a penny from the fund.
“But even that wasn’t enough in the end,” said one source close to the talks.
By Monday morning, the market began to move against Peloton again, starting a new wave of problems.
Desperate attempts were made to find a buyer, with the hedge funds Citadel and GLG Partners among those contacted about a possible deal, but to no avail.
In a letter he sent to his investors last week explaining his actions, Beller insisted there had “not been any material deterioration in the credit quality of the fund’s assets”.
The trouble, Beller said, was the lack of liquidity in the credit markets as a whole.
“In addition,” he went on, “because of their own well-publicised issues, credit providers have been severely tightening terms without regard to the creditworthiness or track record of individual firms, which has ... made it impossible to meet margin calls.”
It is these comments that sent the chill of fear through the City.
Beller is seen by many as a victim. If the banks continue to tighten their lending terms, Peloton will not be the only fund that runs out of road.
