Paolo Pellegrini: Short Treasuries, Long Oil & Sees 'Anemic Real Returns' In Equities ~ market folly

Monday, October 5, 2009

Paolo Pellegrini: Short Treasuries, Long Oil & Sees 'Anemic Real Returns' In Equities

While you may not be familiar with Paolo Pellegrini, you should be. The 52-year old used to work for John Paulson's hedge fund Paulson & Co and played an integral part in the research and investment ideas that led to Paulson's astonishing 570%+ return in 2007. As we covered on the blog before, Pellegrini has since left Paulson and started his own fund PSQR Management LLC with $100 million of his own money and will open to outsiders in 2010. PSQR's name has meaning for two reasons. Firstly, it is Paolo's initials squared (Paolo Pellegrini: P Squared). Secondly, it is an anagram for SPQR, or Senatus Populusque Romanus (Senate and the People of Rome). Pellegrini is a Rome native and this highlights the initials of the ancient Roman Republic as a tribute to his background.

In 2006 Pellegrini, a Harvard MBA, decided that the housing bubble was about to burst after he sifted through tons of housing data. In Spring of 2008, Pellegrini saw the severity of the situation and knew that massive government assistance would be needed which would send both stocks and the U.S. dollar down. Needless to say, he's been spot on both with his economic calls and his execution of a trading strategy that would profit from the crisis.

Strategy, Portfolio & Performance

Upon starting his fund, he shorted exchange traded funds (ETFs) that were loaded with financial stocks (most likely ticker XLF or some similar ETF), as well as S&P500 index ETFs (SPY, etc). In late 2008 he shifted his bets to the Treasuries market by shorting long-term treasuries. This is a trade we saw many hedge funds put on in the past and we recently detailed Julian Robertson's curve cap play that bets on rising long-term Treasury yields. And, Pellegrini expects the fall in Treasury prices (and rise in yield) to continue. He is taking a global macro approach by trading anything and everything he pleases, as long as it will help him make money off his theses. He has an uncanny ability to take an economic situation and turn it not only into a trade, but a profitable one.

Pellegrini is also bullish on commodities, especially those that are scarce or of daily necessity. In particular, he likes oil and has been buying oil futures. He likes commodities since he sees global competition for them elevating. Given this commodity thesis, he also likes the Australian Dollar as the country benefits from their natural resources. Pellegrini also has owned the Norwegian kroner which is interesting, as we saw Julian Robertson also recommended this currency. In a way, Pellegrini's theses here are also similar to that of legendary Quantum fund manager Jim Rogers. Rogers likes commodities and various currencies of commodity producing countries as we noted when we detailed Rogers' portfolio & positions.

Performance wise, Pellegrini has kept up the great numbers he helped generated at Paulson & Co. From April 2008 until December 2008, PSQR was up over 52%. Year-to-date through July for 2009, PSQR was up 80% largely on the heels of success in the Treasury market.

Thoughts on the Market

Given the sour economic situation he uncovered while at Paulson, Pellegrini still has a gloomy outlook for the economy. He sees the market essentially trading sideways and could even generate negative returns once you adjust it for inflation as he calls for "anemic real returns." The point is, he doesn't really see things going up by much as he cites budget deficits, household debt, and increased regulation amongst other things. As mentioned earlier, Pellegrini has been shorting long-term Treasuries and going long crude oil in a wager that was formulated on the basis of dollar devaluation. He cites massive stimulus programs, huge corresponding deficits, and the fact that the US is now a debtor nation as reasons for the currency's value dropping. While Pellegrini takes a long-term view in formulating his theses and putting on his trades, he does note that due to policy shifts and the market volatility, that his positions can (and will) change with the ebbs and flows of all the intertwined parts.

Pellegrini recently sat down for an interview on Bloomberg TV and we've embedded the video below. He discusses his strategies and his view on the economic trends we're seeing these days:

Obviously, Pellegrini paints a rosy picture... /sarcasm. He thinks fiscal stimulus and quantitative easing are not the solution and has been critical of the move the Federal Reserve has made. Pellegrini has been vocal in the past as he looks to solve the mortgage and housing crisis since it is at the root of much of America's problems. You can read some of Pellegrini's mortgage solutions here. He also sees a real decline in economic activity and some asset inflation as well.

John Paulson has called his former colleague "extremely smart and capable" as they previously met at Bear Stearns before moving on to Paulson & Co. Paulson has made a wager of his own when we saw that Paulson was buying financials. While this could have just been a trade, it is still interesting to see the difference of opinion. As you undoubtedly already know, hedge fund Paulson & Co also has a large gold position as they look to hedge their fund share class denominated in gold. But interestingly enough, they also have stakes in numerous gold miners. We'll continue to track the differences in thought and strategy between Paulson and PSQR as the economy meanders along.

Pellegrini parted ways with his former colleague because he always desired to run his own show and to run a true macro fund. Currently, PSQR is a smaller firm that recently hired Alex Patelis away from his position as Chief International Economist at Merrill Lynch in London. While he may run a smaller firm for now, you better believe that he has the credentials and the track record to succeed. The one question mark surrounding him is his ability to operate in futures markets, as he is relatively inexperienced there. We're sure he'd be quick to point to his winning Treasuries trades to refute that point though. But in the end, the majority of his experience lies in mortgage related markets and it will be interesting to see if he can continue to translate his economic theses into profitable macro trades. For more on Pellegrini, check out this in-depth profile of him from Bloomberg.

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