Hennessee Group LLC, an adviser to hedge fund investors, notes that while some hedge funds focused on mortgage backed securities have suffered well publicised losses related to the decline in the sub-prime mortgages space, many hedge funds have also been able to generate profits as a result of its decline.
In an October 2006 Hennessee Group reported that hedge funds have been using credit default swaps (CDS) in several ways, including purchasing CDS on sub-prime mortgage backed fixed income securities and indices intended to profit from deterioration in credit quality among mortgage borrowers.
In what has been the best short sale theme since 2002, many hedge funds have greatly benefited from the collapse in sub-prime mortgages via their short exposure to mortgage lenders and sub-prime mortgage backed securities and indices.
While some have focused on shorting mortgage lenders and buying credit default swaps (CDS) on specific mortgage backed bonds, others have elected to purchase CDS on indices of these securities (the ABX series), with most focused on those securities issued in 2006 under more relaxed lending standards.