FORTUNE -- In less than five years, mortgages have gone from toxic to tonic.
It's the same life span as the annual hedge fund conference SALT, where many of the top professional managers met last week to talk investments, hear speeches from luminaries like Al Pacino, and generally have a good time. In all, Las Vegas SALT, officially the SkyBridge Alternatives Conference, drew 1,800 attendees -- hedge funders, but also accountants, lawyers, and others who service the industry. The conference wrapped up on Friday with an appearance from Oliver Stone and a pool party. (See A Davos grows in the desert)
This year, what people seemed to be talking about more than anything else on the investment panels and in the hallways was the mortgage market.
On a panel on investing in home loans, investors seemed to agree that the shrinking of mortgage giants Fannie Mae and Freddie Mac as well as new rules that make it more expensive for banks to hold onto mortgages are creating a great opportunity for hedge funds. "The banks will leave a huge vacuum," says Josh Birnbaum, a former Goldman Sachs (GS) trader who helped create the firm's so-called big short against housing before starting his own hedge fund, Tilden Park. "There are lots of ways to play the game."
Anilesh Ahuja, manager of the mortgage-focused Premium Point Investments, says a lack of new home construction over the past five years almost ensures housing prices will continue to go up. Already, he said rising home prices are rapidly shrinking the number of people around the country who owe more on their house than it is worth. That's likely to result in fewer foreclosures, and fewer mortgage bond losses.
But the mortgage market seemed to be a favorite even of those who don't typically invest in the sector. Stephen Toy, who works for famed distress investor Wilbur Ross, said his firm was looking at buying mortgage servicing rights from banks. Daniel Loeb said he had $2 billion of his $11.7 billion fund in mortgages and other consumer credits.
Indeed, the tone at the conference in general was upbeat, so much so that it often seemed out of step with the rest of the economy. A Latin-themed party around the pool at the Bellagio, where the conference was held, on Thursday night featured dancers, some in full Vegas showgirl attire, and a cigar rolling station. The party had so much food that at one point an entertainer urged the crowd to eat up. "It's free food for rich people," he said, which got a laugh.
Some media reports have taken shots at SALT and its founder Anthony Scaramucci for being over the top. Ironically, the conference has blossomed during a period in which hedge funds haven't done all that well. On average hedge funds have underperformed the market for the past four years. Last year, the average fund rose 5.5% versus a 13% rise for the S&P 500 (SPX).
The industry has come under fire for its high fees -- some claim the funds return nearly all their gains to the managers instead of the investors. Later this year, the Financial Stability Oversight Council could put some of the industry's biggest and most successful hedge funds on its list of firms that could cause economic damage if they were to fail, which could lead to regulations. None of that, though, seems to stop the hedge fund industry, which continues to see its assets rise despite the weak performance.
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Mortgage hedge funds have been the exception, up 20% on average last year. Birnbaun's Tilden Park was up 41%. Steve Kuhn of mortgage-focused hedge fund Pine River, which was up 35% last year, says new regulations are making it prohibitive for borrowers who have home loans of $100,000 or less to refinance. The longer those borrowers stay in the relatively high-rate mortgages they got a few years ago the better it is for Kuhn and mortgage investors like him. At the same time, Kuhn and others are helping banks unload their unwanted mortgages so they can make new loans. It's a win-win, though who is winning more is hard to tell.
In part, all of the talk about mortgages at SALT may have been the result of an echo chamber. Scaramucci's SkyBridge, which puts on the conference and does the inviting, creates hedge funds that invest in other hedge funds. And SkyBridge's funds have had a big investment in mortgage hedge funds. And some of the talk about the mortgage funds was whether they could repeat their stellar performance this year. SkyBridge, for one, seemed skeptical. Troy Gayeski, a senior portfolio manager at SkyBridge, said the firm was looking to pare back its mortgage investments.
Still, most of the people I talked to at the conference seemed to think mortgages would remain a hot hedge fund investment. One fund manager said it's a trend tied to the broad restructuring of the U.S. economy. And the mortgage market is unlikely to go back to what it was before the crash anytime soon. At least, let's hope.
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