The Danes invented handball and they are mad about football. But their real national sport is deciding when to refinance their mortgages.
The $440 billion Danish mortgage bond market is more than 200 years old, and legend has it there’s never been a single default. When Denmark, the country, went bust during the Napoleonic wars, its notoriously efficient mortgage-bond market chugged along without investors taking a hit.
Danes are obsessed with checking the price of their bond-backed mortgages to decide when to exercise a call option that lets them buy back their debt and refinance it at better rates. But a hedge fund inside the country’s biggest mortgage lender, Nykredit Realkredit A/S, has found a way to deliver double-digit returns on the AAA-rated bonds by taking advantage of mispriced call options.
For Nykredit MIRA, which invests in the callable bonds that make up about one-third of the Danish mortgage market, the advantage of local knowledge is key, according to Henrik Jorgensen, head of fixed income at Nykredit Asset Management. He oversees total assets of about $15 billion, with the $250 million hedge fund he helps run boasting an annual return of 11 percent since its inception in 2008. So far this year, it’s returned about 7 percent.
“One of the things we constantly do over and over again is to look at different measures showing whether the market is paying too much or little for the prepayment risk,” Jorgensen said in a phone interview on Monday. “So it’s really about knowing every corner of this constantly changing market.”
Jorgensen and his team try to assess the probability of prepayment. It uses leverage and constantly hedges positions as duration and other risks change.
“When you have prepayments it’s human behavior,” Jorgensen said. “It’s not a machine telling people what to do with their loans. This gives opportunities for investors, but on the other hand, debtors have historically been extremely effective regarding prepayments, so risk on your positions in Danish callable bonds can change fairly quickly.”
Investors need to be aware that “Danish debtors are really efficient when it comes to prepaying,” he said. “Some say it’s a national sport.”
The fund typically makes bets that look three to six months into the future and then invests in what it deems are the underpriced corners of the market.
“Currently 1.5 percent coupons with 20-year maturities still look extremely good,” Jorgensen said. “Carry positions in 3 percent with 30-year maturities is still a big place for us to be.”