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Have Sovereign Funds Embraced Fannie and Freddie’s New Mortgage Babies?

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mbs

The answer is a partial yes. State-owned housing behemoths Freddie Mac and Fannie Mae have tapped into two major investment themes. The first theme are asset owners such as sovereign wealth funds and U.S. pensions’ unquenchable desire for fixed income yield. Whereas the likes of large wealth funds such as Singapore’s GIC go direct when investing in yield investments, while some wealth funds with smaller in-house capabilities opt to use intermediaries such as money managers and hedge funds to get this type of exposure. The second theme circles around risk transfer. Fannie Mae and Freddie Mac want to move as much risk as possible into these these mortgage insurance-like products. These new securities which monitor credit events, could expose these investors to lose some or all of their principal if the underlying mortgages default. With wealth funds fixated on yield, these new securities distribute risk of mortgage default to different tranches – sound familiar? Fannie Mae’s has called these products the Connecticut Avenue Securities, while Freddie Mac’s calls them Structured Agency Credit Risk (STACR). Typically for the STACR bonds they are held in 4 structures. M1 and M2 are usually rated and more conservative. M3 is usually not rated. Finally, the riskiest, the Class B bond, is treated as a derivative for U.S. federal income tax purposes in most cases.

Freddie Mac Issued STACR Transactions to Date

Transaction Issuance Date Issuance Volume – USD
STACR 2013-DN1 July 26, 2013 500,000,000
STACR 2013-DN2 November 12, 2013 630,000,000
STACR 2014-DN1 February 12, 20114 1,008,000,000
STACR 2014-DN2 April 9, 2014 966,000,000
STACR 2014-DN3 August 11, 2014 672,000,000
STACR 2014-HQ1 August 11, 2014 460,000,000
STACR 2014-HQ2 September 15, 2014 770,000,000
STACR 2014-DN4 October 28, 2014 611,000,000
STACR 2014-HQ3 October 28, 2014 429,400,000
STACR 2015-DN1 February 3, 2015 880,000,000
STACR 2015-HQ1 March 31, 2015 860,000,000
STACR 2015-DNA1 April 28, 2015 1,010,000,000
STACR 2015-HQ2 June 9, 2015 425,600,000
STACR 2015-DNA2 June 29, 2015 950,000,000
STACR 2015-HQA1 September 28, 2015 872,000,000
STACR 2015-DNA3 November 2015 1,070,000,000
Total   12,114,000,000

 
Source: Freddie Mac filings

Ownership Splits by Investor Type

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Will CalPERS Double its Allocation to Private Equity?

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Yu Ben Meng, the new Chief Investment Officer of the California Public Employees Retirement System (CalPERS), detailed a picture on why the institutional investor needs to augment its allocation to private equity. [ Content protected for Sovereign Wealth Fund Institute Standard subscribers only. Please subscribe to view content. ]

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Minutes Describe Fed Expecting to End Balance Sheet Reduction by Year-End

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The U.S. Federal Reserve board released minutes from its January 2019 meeting. There was a split among board members whether any interest rate increases would be necessary for this year. In addition, these officials chatted about ceasing the reduction of bonds on the central bank’s balance sheet before the end of 2019. Board members are keeping an eye on the stock market and current credit spreads. The Federal Reserve started reducing its bond portfolio in October 2017, a measure of quantitative tightening (QT). The US$ 3.8 trillion pool of bonds held by the central bank’s balance sheet is a topic of concern for U.S. fixed income investors.

Minutes of the Federal Open Market Committee
January 29-30, 2019

An excerpt from the minutes details that “Participants commented that, in light of the Committee’s longstanding plan to hold primarily Treasury securities in the long run, it would be appropriate once asset redemptions end to reinvest most, if not all, principal payments received from agency MBS in Treasury securities. Some thought that continuing to reinvest agency MBS principal payments in excess of $20 billion per month in agency MBS, as under the current balance sheet normalization plan, would simplify communications or provide a helpful backstop against scenarios in which large declines in long-term interest rates caused agency MBS prepayment speeds to increase sharply. However, some others judged that retaining the cap on agency MBS redemptions was unnecessary at this stage in the normalization process. These participants noted considerations in support of this view, including that principal payments were unlikely to reach the $20 billion level after 2019, that the cap could slightly slow the return to a portfolio of primarily Treasury securities, or that the Committee would have the flexibility to adjust the details of its balance sheet normalization plans in light of economic and financial developments. Participants commented that it would be important over time to develop and communicate plans for reinvesting agency MBS principal payments, and they expected to continue their discussion of balance sheet normalization and related issues at upcoming meetings.

Following the discussion, the Chairman proposed that the Committee communicate its intentions regarding monetary policy implementation and its willingness to adjust the details of its balance sheet normalization program by publishing a statement at the conclusion of the meeting. All participants agreed with the proposed statement.

STATEMENT REGARDING MONETARY POLICY IMPLEMENTATION AND BALANCE SHEET NORMALIZATION
(Adopted January 30, 2019)

After extensive deliberations and thorough review of experience to date, the Committee judges that it is appropriate at this time to provide additional information regarding its plans to implement monetary policy over the longer run. Additionally, the Committee is revising its earlier guidance regarding the conditions under which it could adjust the details of its balance sheet normalization program.5 Accordingly, all participants agreed to the following:

The Committee intends to continue to implement monetary policy in a regime in which an ample supply of reserves ensures that control over the level of the federal funds rate and other short-term interest rates is exercised primarily through the setting of the Federal Reserve’s administered rates, and in which active management of the supply of reserves is not required.
The Committee continues to view changes in the target range for the federal funds rate as its primary means of adjusting the stance of monetary policy. The Committee is prepared to adjust any of the details for completing balance sheet normalization in light of economic and financial developments. Moreover, the Committee would be prepared to use its full range of tools, including altering the size and composition of its balance sheet, if future economic conditions were to warrant a more accommodative monetary policy than can be achieved solely by reducing the federal funds rate.”

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Vision Fund Investors Display Stress on Frothy Market Valuations

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Led by Masayoshi Son, Japan-based SoftBank Group Corporation continues to run the gargantuan Vision Fund scooping up exciting technology investments, both big and small globally. Armed with a roughly US$ 100 billion warchest, the Vision Fund has been disrupting both suppliers of capital and the industries that receive it. Are the big-money limited partners of the Vision Fund the technology backers of last resort? Two of the major backers of the Vision Fund are Saudi Arabia’s Public Investment Fund and Abu Dhabi-based Mubadala Investment Company. SoftBank has invested billions into tech companies like Compass, Katerra Inc, WeWork Cos., Coupang, DoorDash, and Uber Technologies. For example, a beneficiary of the Vision Fund, Katerra is a manufacturer of modular building parts, in which many people question the company’s profitability and business model. Uber is driving toward its initial public offering. SoftBank recently participated in an investment round in Clutter, a storage company.

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