A little-known hedge fund was a big contributor to last summer’s subprime mortgage crisis, while the fund itself profited from its skillful swaps, writes the Wall Street Journal.

Magnetar Capital, founded in 2005 by Alec Litowitz, formerly of Citadel Investment Group, created several of the worst-performing collateralized-debt obligations (CDOs).

The $9 billion hedge fund bought credit default swaps on the riskiest portions of the CDOs while they were paying high returns and hedged its holdings by betting against the less-risky portions of the same securities.

Magnetar lost money on many of the risky investments, but made huge profits when its hedges paid off as the market collapsed last fall. Thanks to the way it hedged these trades, the fund returned 25% across a range of stock and debt strategies.

Many hedge funds realized early on “that the loans and securities that went into CDOs were extremely toxic, and they designed structures to exploit that,” says Janet Tavakoli, a structured-finance consultant.

"There was a certain amount of luck to timing the subprime trade right," says Don Brownstein, CEO of Structured Portfolio Management, an $820 million hedge fund that made a profit of more than 180% last year by shorting subprime securities.

Subscribe Now

Access to premium content including in-depth coverage of mutual funds, hedge funds, 401(K)s, 529 plans, and more.

3-Week Free Trial

Insight and analysis into the management, marketing, operations and technology of the asset management industry.