Florida Hedge Fund’s Business Turns Sour
This article is from the archive of The New York Sun before the launch of its new website in 2022. The Sun has neither altered nor updated such articles but will seek to correct any errors, mis-categorizations or other problems introduced during transfer.

After realizing double-digit returns for seven of the last eight years, Spyglass Capital, a Naples, Fla.-based hedge fund, has seen its business model backfire to the tune of a 14.88% loss this year.
As a result of the fund’s losses it has been forced to sell assets to meet investor redemptions, shrinking it to $180 million from $310 million in March.
The fund’s primary portfolio – the Spyglass Capital Offshore Fund – has gone from approximately $200 million in assets this year to $42 million, according to people familiar with the fund.
Moreover, the losses come on top of the fund’s 2.34% drop last year, its first losing year since opening in July of 1996.
For comparison, the 121-fund Hedgefund.net fixed-income arbitrage index of is up 4.96% this year.
Prior years have been particularly lucrative for Spyglass, especially 2001 and 2002, where the offshore fund posted 39.15% and 22.96% returns, respectively. The fund posted a 1.13% gain in September.
Spyglass Capital’s founder and chairman, Paul Brodsky, declined comment. An individual familiar with the fund said the fund has been closed to new investors as it reemerges from a five-month period of investor withdrawals.
The losses this year resulted in problems related to hedging the fund’s positions in mortgage-backed derivatives – bonds created from bonds backed by residential mortgages, often with complex principal and interest payment features.
Moreover, these bonds trade much less frequently than other mortgage bonds, with little current pricing information available. Mr. Brodsky, in an August letter to investors obtained by the Sun, wrote that the fund’s woes are due in part to “over-hedging our core securities at substantial cost when it would have been wiser to sit on our hands.”
In the August letter, Mr. Brodsky wrote that the fund’s hedging decisions were made on the belief that interest rates would rise much more rap idly than they have.
Another problem for Spyglass Capital is the nature of their business: rather than actively managing a portfolio of securities like most hedge funds, the fund seeks to act as an exchange, or market maker, for the most complex and illiquid derivatives in the mortgage market. In its marketing material, the fund refers to “providing market liquidity for relatively unmarketable securities.” The attractiveness of this strategy for the fund is that it gets to buy bonds that offer cash-flow producing high-yields, and often for low prices, since they are the only consistent buyer in the market. When another buyer emerges for these bonds, they can mark the paper up handsomely, since they are frequently the only available seller.
However, there are risks associated with this strategy.
The biggest problem with a hedge fund being a liquidity provider in such a market is that there are few others willing to buy and sell such volatile bonds.
Thus when Spyglass Capital’s hedging decisions proved unprofitable, and investors wanted their capital back, there were few investors or dealers willing to buy this paper, which forced the fund to sell at losses. In his July letter to investors, Mr. Brodsky wrote that the wide bid/ask spreads in this market “are a significant liability in this market as we liquidate.”
Fortunately for the fund, it does not use leverage, which would have compounded its problems, as it would have been forced to sell more bonds and accept an even lower price for them.