McCarty, Who Foresaw Bear Stearns Collapse, Plans Hedge Fund

Date: Wednesday, July 8, 2009
Author: Jeff Kearns, Bloomberg

Michael McCarty, former chief equity and options strategist at Meridian Equity Partners Inc. in New York, plans to start a hedge fund next month that will make bets on price discrepancies between similar exchange-traded funds.

McCarty, 49, said he is starting Differential Investment Partners LLC with Bret Rekas, 40, who helped oversee about $350 million at Somerset Asset Management LLC in Minneapolis.

“There’s an opportunity to create a portfolio with consistent, positive returns and little volatility,” McCarty said in an interview. “That’s the holy grail of investing.”

McCarty, who wrote daily reports on unusual options activity and stock-market volatilty at Meridian, said two days before Bear Stearns Cos. was bailed out by JPMorgan Chase & Co. and the Federal Reserve that options trading showed traders were betting the stock may plunge to “zero.” Bear Stearns closed at $30 on March 14, 2008, the last trading day before JPMorgan agreed to buy it for $2 a share.

Investors are boosting their use of ETFs to bet on indexes, industries, commodities and other assets. U.S. ETFs held $582 billion as of May, more than doubling from $228 billion at the end of 2004, according to the Investment Company Institute, a Washington-based trade group that represents mutual funds.

McCarty said he and Rekas will use an arbitrage strategy that will attempt to profit from the gaps in pricing for different ETFs that track similar indexes or assets, including so-called leveraged ETFs that amplify gains or losses. The two have known each other since 1994, when they worked together at Donaldson Lufkin & Jenrette, the investment bank acquired by Credit Suisse Group AG in 2000.

Imperfect Tracking

ETFs, which are listed on exchanges and trade like stocks, don’t perfectly track the securities or indexes they are meant to follow. The SPDR Trust, which is meant to follow the Standard & Poor’s 500 Index, has fallen 1.25 percent in 2009. The underlying index has dropped 1.38 percent.

Hedge funds are largely unregistered pools of capital that cater to wealthy individuals and institutions and allow managers to participate substantially in profits from investments. They try to make money in rising as well as falling markets.

To contact the reporter on this story: Jeff Kearns in New York at jkearns3@bloomberg.net.