“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.

Dodd-Frank

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.

Named the Collins amendment after its advocate, U.S. Senator Susan Collins, a Republican from Maine, the provision on “leverage and risk-based capital requirements” bars lenders from using so-called trust preferred securities, or TruPS, to boost their capital ratios because of concern that the assets wouldn’t cushion losses during a crisis.

TruPS combine debt with equity, and lenders issued about $150 billion of the hybrid securities before 2009, according to the Federal Reserve Bank of Philadelphia. The assets were attractive for banks because they got a capital boost while being able to deduct interest payments from their tax bills.

Lenders could also suspend interest payments on TruPS if needed, which banks did to conserve cash during the financial crisis. That, combined with fears that banks would fail, sent the securities plunging.

TruPS Buybacks

Financial firms have now been buying TruPS back at a premium to their market values and retiring the assets because banks don’t want to pay yields in excess of 5 percent on securities that provide no benefit to capital, said Arthur Tetyevsky, a strategist at Jefferies Group Inc. in New York.