2012 Markets Will be a Repeat of 2011, Favor Italian Government Bonds Over Nation's Bank Debt

By: Bloomberg

Boaz Weinstein, founder of Saba Capital and former co-head of credit trading at Deutsche Bank, spoke exclusively to Bloomberg TV's Stephanie Ruhle about the CDS market and outlook for 2012.

Weinstein said that "we do have a long position in Italy" and the markets this year will "be a repeat of 2011."

Weinstein on markets in 2012:

"It's really going to be more of the same. The market is so opaque right now."

"I'd much rather focus on the relationship between two related instruments, the stock of a company and the debt of the same company, than to go to sleep at night wondering what headline might shake the market up or down in a surprising way. I think 2012 is going to be a repeat of 2011. It's going to be a very challenging year for managers to find good investments."

On his relationships with banks:

"In the last three to five months there's a noticeable level of risk aversion at banks. And so if you go and ask our various counterparties to provide liquidity, they're not doing it as much. So what it means is that the rest of the investor base, funds like ourselves, when a client needs to buy or sell something we're often on the other side of that trade. The dealer, the bank, is now acting more as agent rather than as principal."

On what keeps him up at night:

"Since August I've been waking at 3:00 a.m. to look at the European markets. It's been interesting. It's not just a chore. It's not just an important thing to do...I think that Europe is going to be the major focus again for the markets in 2012, almost without a doubt."

On investing in Italian debt:

"We think Italian debt above 7% right now looks mispriced, looks attractive to us relative to the equity markets, relative to the debt of Italian banks, for example. And so we do have a long position in Italy, the sovereign."

On sovereign CDS:

"There is this open question about Greece. I think we can start by looking at the market- Greece CDS has never been more valuable. If you wanted to go and buy this CDS that some people wonder is it valuable, it's never more expensive. The market is speaking and saying actually Greek CDS has a lot of value. The real question is around the restructuring that's occurring, the PSI. Should that trigger CDS? In our view, so long as the average investor has the right to decide, it shouldn't trigger CDS and it doesn't speak negatively for the validity of the product."

On how Saba is positioned on European banks:

"It's interesting when you look at European banks compared to the sovereigns because take a bank in a country and that country's debt. Let's take Italy, for example. It is unusual that sovereign debt, because it has this technical problem that we talked about where there's too many sellers who owned it because they wanted to own riskless assets, are selling and driving the yields up. Yet the bank debt, even though it's much riskier than the sovereign debt, is trading at pretty much the same level. So if you look at history, you won't find too many examples where a country defaulted and its banks were okay, especially banks that have a lot of exposure to the sovereign."

"And so we think bank debt is unattractive compared to sovereign debt because there could be many examples and there have been in the past where bank defaults, like we had in Iceland in 2008 or even Ireland in 2011, the bank defaults, the sovereign lives on and survives. And so we think that's an interesting relationship."

On how the credit derivatives product has changed in the last ten years:

"There's been a tremendous amount of standardization in the product. So even just the contracts that every firm trades off of the same language and really making that the contract harmonious across counterparties was put in place, finally, the last peg in the ladder was 2009, the big bang protocol. And since then the product has been very standard. And of the legacy issues have really left. In addition, it's become much more liquid. So billions of notional is traded every day in the CDS market. And the bid offer spread tends to be less than it is. So the price of getting in and out is less than it is in the bond and loan market."

"And lastly, just transparency. So if we wanted to go and check a random company and see where their CDS level is-- it's really very easy. One of a dozen banks put out prices throughout the day. And so CDS often is maligned for being this opaque thing. But in the main, the credit default swap is actually a pretty simple, straightforward instrument."

On Warren Buffett saying that derivatives are weapons of mass destruction:

"Ironically, after he said that infamous line, it became known to Berkshire investors that Mr. Buffett was actually one of the largest players in the equity derivatives and credit derivatives space. And so I don't really know what he was getting at with that comment. But I think it's unambiguously true that derivatives have lower borrowing costs for corporate institutions and just the ability for banks to hedge has also allowed them to extend more credit. And so I think, on the whole, derivatives have actually played a very positive effect on the economy."

On Saba's plans for 2012:

"We'd like to just continue doing what we've done over the years, which is invest in relative value. That doesn't mean we're neutral to everything. We do have a long bias in the U.S. versus a short bias in Europe, and that's because of the fragility of the European economy. But in general, most of our returns are going to come from mis-pricings between a company's debt and equity or two year and ten year. And these are the sorts of strategies that we really spend most of our investors' capital on."

On Pershing Square's Bill Ackman calling him one of the two most important people in the credit markets space and who he believes is the other:

"In deference to Bill, who I've known for many years, he may have meant himself, which in fact it would actually be a reasonable comment because he's done very well as a credit investor. I don't know who he meant, but maybe he was joking."

On whether he's looking at the sell side to pick up talent:

"Like any fund, we're always looking for talented people. That goes without saying. But I think there are still very talented traders at banks that could work out very well in the buy side. So, yes, we are looking to grow...If you hire one, it's like shark teeth. There's another five behind it."

bloomberg.com

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