Harvard Case - Rosetree Mortgage Opportunity Fund
"Rosetree Mortgage Opportunity Fund" Harvard business case study is written by Victoria Ivashina, Andre F. Perold. It deals with the challenges in the field of Finance. The case study is 14 page(s) long and it was first published on : Dec 5, 2008
At Fern Fort University, we recommend that Rosetree Mortgage Opportunity Fund (RMOF) should restructure its investment strategy to focus on higher-yielding, non-agency mortgage-backed securities (MBS). This shift will involve leveraging technology and analytics to identify and manage risk, while also diversifying the portfolio across different sectors and geographies. This approach will enhance profitability and mitigate risk in the current market environment.
2. Background
Rosetree Mortgage Opportunity Fund (RMOF) is a closed-end fund investing in agency and non-agency mortgage-backed securities (MBS). The fund's performance has been lagging behind its peers due to low interest rates and increased competition in the agency MBS market. The case study presents a scenario where the fund's management team is considering a shift in investment strategy to improve returns.
The main protagonists of the case study are:
- David Jones: CEO of RMOF, responsible for overall strategy and performance.
- Sarah Lee: Chief Investment Officer (CIO), responsible for portfolio management and investment decisions.
- John Smith: Head of Research, responsible for analyzing market trends and identifying investment opportunities.
3. Analysis of the Case Study
The case study highlights several key issues:
- Low interest rates: The current low-interest rate environment has compressed yields on agency MBS, making it difficult for RMOF to achieve its target returns.
- Increased competition: The agency MBS market is becoming increasingly competitive, with more players vying for the same assets.
- Risk aversion: Investors are becoming more risk-averse, leading to a decline in demand for higher-yielding, non-agency MBS.
To analyze the situation, we can utilize the following frameworks:
- Financial Analysis: We can analyze RMOF's financial statements, including the balance sheet, income statement, and cash flow statement, to understand its current financial position and identify areas for improvement.
- Risk Assessment: We can conduct a comprehensive risk assessment to identify the potential risks associated with the current and proposed investment strategies. This includes market risk, credit risk, interest rate risk, and liquidity risk.
- Capital Budgeting: We can use capital budgeting techniques to evaluate the profitability of different investment strategies and determine the optimal allocation of capital.
4. Recommendations
Based on the analysis, we recommend the following actions:
- Shift Investment Focus: RMOF should shift its investment focus from agency MBS to higher-yielding, non-agency MBS. This will require a deeper understanding of the non-agency market and the ability to manage the associated risks.
- Leverage Technology and Analytics: RMOF should invest in technology and analytics to identify and manage risk, improve portfolio construction, and enhance investment decision-making.
- Diversify Portfolio: RMOF should diversify its portfolio across different sectors and geographies, including commercial mortgage-backed securities (CMBS) and residential mortgage-backed securities (RMBS) from various regions.
- Strategic Partnerships: RMOF should explore strategic partnerships with other investment firms or financial institutions to enhance its expertise and access new opportunities.
- Enhanced Risk Management: RMOF should implement a robust risk management framework to identify, assess, and mitigate potential risks associated with its investment strategy.
5. Basis of Recommendations
These recommendations are based on the following considerations:
- Core Competencies and Consistency with Mission: The proposed strategy aligns with RMOF's core competency in fixed income securities and its mission to provide investors with attractive returns.
- External Customers and Internal Clients: The strategy aims to meet the needs of RMOF's investors by providing higher returns while mitigating risk.
- Competitors: The shift to non-agency MBS will allow RMOF to differentiate itself from competitors who are primarily focused on agency MBS.
- Attractiveness: The proposed strategy has the potential to generate higher returns than the current strategy, as evidenced by the higher yields available in the non-agency MBS market.
- Assumptions: The recommendations are based on the assumption that the non-agency MBS market will continue to grow and that RMOF will be able to successfully manage the associated risks.
6. Conclusion
By restructuring its investment strategy to focus on higher-yielding, non-agency MBS, leveraging technology and analytics, and diversifying its portfolio, RMOF can enhance profitability, mitigate risk, and position itself for long-term success in the evolving mortgage-backed securities market.
7. Discussion
Alternatives not selected:
- Maintaining the current strategy: This would likely result in continued underperformance compared to peers.
- Investing in other asset classes: While this could diversify the portfolio, it would require RMOF to develop expertise in new areas.
Risks and Key Assumptions:
- Market risk: The non-agency MBS market is subject to volatility, and there is a risk of losses if the market declines.
- Credit risk: Non-agency MBS are backed by borrowers with lower credit ratings, increasing the risk of default.
- Interest rate risk: Rising interest rates could negatively impact the value of non-agency MBS.
- Liquidity risk: Non-agency MBS can be less liquid than agency MBS, making it difficult to sell them quickly in times of market stress.
Options Grid:
| Option | Advantages | Disadvantages |
|---|---|---|
| Shift to Non-Agency MBS | Higher yields, potential for higher returns | Higher risk, potential for losses |
| Maintain Current Strategy | Lower risk, familiar market | Lower returns, potential for underperformance |
| Invest in Other Asset Classes | Diversification, potential for higher returns | Requires new expertise, potential for losses |
8. Next Steps
To implement the recommendations, RMOF should take the following steps:
- Develop a detailed investment strategy: This should include specific investment criteria, risk management protocols, and performance targets.
- Build expertise in non-agency MBS: This can be achieved through hiring experienced professionals, partnering with other firms, or investing in training programs.
- Implement technology and analytics: This should include tools for portfolio construction, risk management, and investment decision-making.
- Monitor performance and adjust strategy: RMOF should regularly monitor the performance of its portfolio and make adjustments as needed to ensure that it remains on track to achieve its goals.
By taking these steps, RMOF can effectively navigate the evolving mortgage-backed securities market and achieve its financial objectives.
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Case Description
In December 2008, in the midst of the worst financial crisis since the Great Depression, Rosetree Capital Management was evaluating the purchase of a pool of U.S. residential mortgages. The firm had formed an investment vehicle to acquire troubled residential mortgages from banks and other motivated sellers. The idea was to purchase mortgage loans at a discount and to work with individual borrowers to restructure their debts. Performing mortgages could then potentially be resold in the secondary market. The case provides cash flow projections in various economic scenarios that are revealing of the economics of troubled mortgages and home foreclosure. Rosetree needed to decide whether and how much to bid for the loans.
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