Greg Lippmann, who helped design the trade against subprime mortgages that became known as the Big Short, says the next financial tremors will come from corporate debt.

The former Deutsche Bank AG trader who now oversees about $3 billion at his LibreMax Capital LLC said in a Bloomberg Television interview that corporate debt and equities will face the biggest pain when the next downturn comes. Investments linked to consumer debt, unlike the last crisis, will be relatively safe because companies have been the ones gorging the most on the ultra cheap interest rates during the past decade.

“If the first quarter’s volatility is a harbinger of something bigger, I think that you’re going to see a lot more trouble in the corporate market and the equity market than the structured products market,” Lippmann said on the sidelines of the Milken Institute Global Conference in Beverly Hills, California. “The consumer is in much better shape than corporates. Consumers are less levered than they were pre-crisis. Corporates are more levered than they were pre-crisis, and I think structured products are not going to be the epicenter.”

While the next recession may not be imminent, Lippmann said it is on the horizon and will be less severe but longer than the global financial crisis of 2008 and 2009. It’s likely to be more akin to 2000 through 2002, he said.

Next Short
While at Deutsche Bank, Lippmann helped devise the mechanism that was used to bet against subprime mortgage debt, a story chronicled in Michael Lewis’s book, “The Big Short" (Lippmann inspired the character played by Ryan Gosling in the 2015 film adaptation).

After starting LibreMax in 2010 with fellow ex-Deutsche Bank trader Fred Brettschneider, Lippmann profited by buying the kind of mortgage debt he shorted while at the German lender. The U.S. housing market has since recovered, however, and LibreMax’s holdings of residential mortgage securities have shrunk from about 80 percent of its portfolio to 20 percent, Lippmann said.

These days, Lippmann is less concerned with finding the next big short, because they’re rare and many trades that appear to have underpriced asymmetric risk turn out to be unprofitable. One example, he said, is a bet some investors have made against retail malls by using derivative indexes to short commercial-mortgage debt.

Instead, Lippmann has been looking for attractive risk-adjusted returns where he can find them. With interest rates still low, it has been difficult for any fixed-income manager to generate strong returns the past few years, he said. And fund managers who have thought they found an obvious short trade have often been squeezed out of it.

“There’s been this underlying cover bid in a lot of markets since the crisis from the people who were prematurely calling big shorts,” Lippmann said.

LibreMax has been investing in structured products, including commercial mortgage securities, collateralized loan obligations and student-loan investments, he said. The fund has also shifted into the debt of some companies with exposure to real estate, such as homebuilders.

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