August 15, 2020

How Pimco’s Cayman-Based Hedge Fund Can Profit From the Fed’s Rescue

A hedge fund like Pimco’s can put money into a U.S.-based vehicle, which then buys asset-backed securities using some combination of cash and short-term loans. The investment vehicle takes the securities to the Fed and gets a TALF loan.

Those TALF funds can be used to pay back whatever the investment vehicle borrowed to buy the asset-backed securities, so that its holdings are funded mostly by the cheap Fed loan, and a sliver of its own money (what is known as a “haircut” in financial parlance). It essentially earns the difference between what it makes in interest from the securities and what it is paying on the Fed loan.

Because investors have just a small amount of money at stake, returns on each invested dollar can be quite high. Investors said they anticipated high single-digit returns in 2020, far lower than the double-digit returns in 2008 but still generous.

The Fed has so far released detailed data only on TALF’s first round of loans, though the program has since finalized another, larger round. In all, it had made $937 million in loans as of last week, mostly against commercial mortgage and small business loan-backed securities. A third round closes on Thursday, and the Fed will most likely release additional data in mid-August.

Pimco’s Cayman Islands-based fund, which has borrowed via a U.S.-based entity called TOCU IX, is one of several foreign investors using an American investment vehicle to gain access to TALF. The pension plan of the Oxford University Press Group will tap the program through a fund set up by the New York-based investment manager MacKay Shields. A Singapore-based fund is a material investor in an offering by the giant financial firm BlackRock, according to the Fed’s first round of detailed disclosures.

The fact that some investors based overseas can make money from TALF does not break Congress’s rules, but it may fall shy of what some lawmakers intended. They specified that loans, advances and asset purchases made under the Fed’s programs should be restricted to “businesses that are created or organized in the United States or under the laws of the United States.” But they said nothing about who could ultimately benefit.

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