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Exactly one year ago I was asked if I would write a piece for NY Magazine regarding an article about Michael Osinski, a former computer programmer/banker who helped generate the algorithms that comprised all the toxic assets that the government later bought from Wall Street.  At the time, Osinski believed that these toxic assets were a fantastic bargain and I largely agreed with him.  A few months before this article I said we were in the midst of a “once in a lifetime opportunity in distressed debt”.  So, I felt comfortable writing the article (I rarely if ever write for other outfits).  Unfortunately, I received a pretty substantial backlash from the article (from some notable sources).  The general response was:

“It is so irresponsible to recommend that small investors buy toxic assets”.

Well, first of all, I wasn’t making, nor do I ever make recommendations for anyone.  That should be ABUNDANTLY clear to any and all readers of everything I write.  I was simply brainstorming about the ways that small investors could gain access to toxic assets because it’s a relatively closed space to the small investor if you don’t have certain connections.  Anyhow, I wrote the following:

“So how can you consider joining Michael Osinski and invest in toxic assets? Well, first of all, let’s make clear that we offer no investment advice or recommendations. That’s not what we know how to do. But so that readers can explore the area further on their own, we asked Cullen Roche, the proprietor of excellent financial blog the Pragmatic Capitalist, to review the various options. Here’s what he said:

Investors who are looking to invest in toxic assets will not gain easy access to “pure plays.” It’s unlikely that your financial adviser or discount broker will have the sophistication or access to create a toxic-asset portfolio for you. The best options for small investors are via the closed-end fund market and exchange-traded funds (ETFs). The following are various ways for investors to gain access to this market:

BlackRock is offering the BlackRock Legacy Securities Public-Private Trust, which will have an initial public offering (IPO) sometime in the fourth quarter of 2009. This will be the first true pure play on the Treasury Department’s Public-Private Investment Program (PPIP) that the public will have access to. PowerShares is also registering two residential mortgage-backed securities (RMBS) products that will likely be ready sometime early next year. Keep an eye out for all three funds to IPO.

For immediate access, the best options for investors are via the closed-end funds and ETFs currently on the market that specialize in government-agency debt, collateralized debt obligations (CDO), mortgage-backed securities (MBS), and asset-backed securities (ABS). The following funds all generate income and/or growth via the toxic-asset market:

BlackRock Income Trust (Ticker: BKT) — The BlackRock Income Trust commenced operations in July 1988 with the investment objective to provide high monthly income while preserving capital by investing in a portfolio of mortgage-backed securities.

Helios Strategic Mortgage Fund (Ticker: HSM) — The Fund seeks to provide a high level of current income by investing at least 80 percent of its total assets in MBS, and may invest up to 20 percent of its total assets in U.S. government securities or cash or other short-term instruments. The Fund’s investments in MBS will include Agency MBS, Non-Agency RMBS, and CMBS.

TCW Strategic Income (Ticker: TSI) — The Fund seeks to generate investment income. The Fund’s investments may include, but are not limited to, dividend-paying equity securities, non-convertible debt securities, high-yield debt securities, mortgage-related securities, and asset-backed securities, in addition to convertible securities.

First Trust Mortgage Income (Ticker: FMY) — The Fund seeks to provide a high level of current income. As a secondary objective, the Fund will seek to preserve capital. The Fund will pursue its objectives by investing primarily in mortgage-backed securities representing part ownership in a pool of either residential or commercial mortgage loans.

Helios Total Return (Ticker: HTR) — The Fund seeks to provide high total return, including short- and long-term capital gains and a high level of current income, through the management of a portfolio of securities.

Investors who are looking to take an indirect equity position in toxic assets might consider the actual banks and real-estate investment trusts themselves. Many of the large money centers and regional banks are still loaded with toxic assets and will either benefit or suffer depending on the underlying asset performance. The Vanguard REIT index will also have a high correlation to the performance of their underlying real-estate portfolio. The following funds are direct plays: XLF, KRE, and VNQ.

But be especially careful here. One of the great unknowns with the financial system is exactly how many bank assets are toxic and whether they’ve come anywhere close to properly accounting for them.”

Even though these ideas were generated well after the market bottom the one year results prove that we were indeed in the midst of a once in a lifetime opportunity:

BKT:  +13.31%

HSM: +20.74%

TSI:  +39.25%

FMY:  +26.35%

HTR:  +18.81%

XLF:  -1.5%

KRE:  +11.73%

VNQ: +39.32%


Average: +21%

S&P 500: +11.45%

Unfortunately, the once in a lifetime opportunity is likely gone as the risk/reward environment has altered dramatically….In fact, distressed debt looks more crowded by the minute….

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