Tips From a Centi-Millionaire Hedge Fund Trader
“I don’t know much about being a millionaire, but I’ll bet I’d be a darling at it.” – Dorothy Parker
John Devaney’s personal net worth is about $250 million. Fifteen years ago, he was a flat-broke college kid.
Today, he is the manager of a successful hedge fund. (And by “successful,” I mean his investors make good returns, not just John.) But his march from zero to an eight-figure net worth started with real estate. In fact, it started while he was in college, with a video program on buying houses with – you guessed it – no money down.
Does that stuff really work?
“Hell yeah,” Devaney told The Financial Times. “I ordered the videos on my Citibank credit card that had a $350 limit. And I bought a house where I cleared $500 a month in cash flow.”
From there, he became part-owner of a bar that made him $50,000 a summer for two summers. By the time he graduated college, he owned a home, several cars and a motorcycle… and he had saved $150,000.
Devaney no longer buys and sells single-family homes. But the investment techniques he uses today are very close to those he mastered as a residential real estate investor.
Devaney’s Horizon hedge fund has about a half-billion in assets. That includes over $100 million of his money. (Like all the best money managers, Devaney puts his money where his mouth is.) He uses that money to buy and sell “asset-backed securities.”
While the idea of buying and selling asset-backed securities may sound complicated, you are probably more familiar with it than you realize – because if you have a typical mortgage, you’re a signer on an asset-backed security. Your house is the asset that acts as security for the bank’s loan. And that loan is usually traded (in a pool with other mortgage loans) as a security.
That puts you in a business that’s similar to John Devaney’s. You’re just on the other side of it. And if you want to begin building a significant net worth, it can be useful to have a basic understanding of the same investment principles Devaney has been applying for the last 15 years.
“Every couple of years there’s a crisis that creates opportunity,” Devaney told FT.He then went on to explain how he bought bonds for about 55 cents on the dollar following the LTCM hedge fund fiasco and Russian debt crisis of 1998.
Of course, those were collateralized bonds. Remember, he buys “asset-backed” securities. So he had a good idea of what he might end up with if, in a worst-case scenario, he had to take possession of the assets themselves and liquidate them.
He also bought aircraft debt when bonds in that category were sharply downgraded after 9/11. He made big profits on pooled leases of aircraft, franchise loans, and mobile home loans as well. Right now, he’s eyeing sub-prime mortgages.
Sub-prime mortgages are the come-on loans often offered to borrowers with questionable credit. They typically have high loan amounts relative to the purchase price of the property. They often have adjustable interest rates (starting with a low, interest-only teaser rate) and usually permit negative amortization. (That’s where you make your minimum payments but your loan balance keeps going up.)
In short, these are the “garbage” loans peddled by money mongers for the last few years that I’ve warned about in ETR and in Main Street Millionaire. The same loans that have, unfortunately, gotten so many unsophisticated home buyers and investors in trouble.
But when these loans start selling at 50 and 60 cents on the dollar, the garbage turns into gold – because the assets backing the loans now actually provide significant protection to investors who buy the loans at these deep discounts.
That’s how the asset-backed securities market works. If there is a contract to deliver a payment, product, or service, and it is secured by something of value, chances are you can buy it. And when you consistently buy those securities on the cheap – as Devaney does – you can make a fortune.
The key, he says, is to realize that “things always cycle” and to be “ready for the opportunities.” For Devaney, that means buying when others are selling in a panic, and selling when others are overly eager to buy.
In real estate – like it or not – we are entering a period when many property owners who used garbage loans to buy at the height of the market will be selling in a panic. If you have investors with a few million dollars, you can do very well buying distressed loans with the right collateral.
Or you can just buy the asset itself on the cheap. From single-family homes to multi-unit apartment buildings, foreclosures are on a dramatic rise in much of the country. Line up your short-term financing – with private money or credit lines – and you may be able to snap up some extraordinary deals.
But be sure to buy significantly under value and at prices that will cash flow once you put your permanent lower-rate and fixed-rate financing in place. Do this consistently, and you may find yourself growing your cash flow and your net worth, just like John Devaney does it.
[Ed. Note: Justin Ford is the president of Pax Property Investments and the editor of Main Street Millionaire., a program teaching deep-value strategies for building equity and income from property investments.]