For many hedge funds, financial rules and state intervention in markets are anathema. Emanuel J. Friedman, former co-chairman of investment bank Friedman, Billings, Ramsey Group Inc., sees them as an opportunity.

Friedman’s $2.6 billion EJF Debt Opportunities Fund surged 29 percent last year by making bets on how lenders would alter their capital structure after the Dodd-Frank Act, according to investors in the pool. Run from suburban Virginia, five miles west of the U.S. Capitol, it has averaged gains of 21 percent a year since inception in June 2008, compared with the 4.4 percent annual increase posted by other debt-focused hedge funds.

His approach comes at a time when some hedge-fund managers, including Third Point LLC’s Daniel Loeb and Moore Capital Management LLC’s Louis Bacon, bemoan political intrusion and complain that Washington is anti-business. Friedman, 66, was on the receiving end of government pressure himself eight years ago, when he left the bank he co-founded amid a probe and subsequent settlement with U.S. regulators over improper trades.

“While a lot of investors avoid uncertainty, others see it as a trading opportunity,” said Stephen Myrow, managing director of Washington-based ACG Analytics, a firm that provides political intelligence to hedge funds and other clients. “If you understand how government works and can properly assess the politics of the moment, you can capitalize.”

Friedman runs the debt fund with senior portfolio manager Jeffrey Hinkle, who joined EJF in 2007 after working as a stock analyst at FBR. Another veteran of Friedman’s old investment bank who followed him to the hedge fund is EJF Chief Operating Officer Neal Wilson, a former Securities and Exchange Commission attorney who helped manage FBR’s hedge-fund and private-wealth business. Wilson said the firm wouldn’t comment for this story.

Washington Base

Friedman’s strategy is to take advantage of the unsettled regulatory environment and government’s heavier hand in everything from bank oversight to housing policy.

It helps that EFJ operates in Arlington, Virginia, outside the traditional hedge-fund enclaves of New York and Greenwich, Connecticut. Proximity to Congress, the Treasury Department and the Federal Reserve, the nerve centers of the $700 billion banking bailout in 2008, hasn’t hurt. The debt fund has never had a losing year.

Friedman outlined his tactics in a December 2011 marketing document obtained by Bloomberg News, saying EJF takes advantage of the shift in power from financial executives to regulators by trading securities that banks will target to clean up their balance sheets in response to new rules.

Regulatory Pressure

“Catalysts” Friedman lists for his investments are Dodd- Frank, the Basel III international capital rules that began to take effect this year and “regulatory pressure to reduce operating leverage.”

Along with securities issued by banks, EJF bets on housing as well as collateralized debt obligations, which are made up of pools of real-estate loans. The Fed took on CDOs as part of its 2008 rescues of Bear Stearns Cos. and American International Group Inc.

The debt fund gained 1.46 percent in 2011, 20 percent in 2010, 32 percent in 2009 and 14 percent over the second half of 2008. Firm-wide, Friedman’s EJF Capital LLC managed $3.1 billion at the end of July, according to an SEC filing.


The genesis for one of EJF’s winning trades is tucked into section 171 of Dodd-Frank, the regulatory behemoth approved by Congress to lay out new rules for Wall Street in the wake of the credit crunch.