Important: What follows is not a recommendation to buy or sell Prodesse Investment Limited. I’m just a private investor, storing and sharing notes. Read my disclaimer.

Name: Prodesse Investment Limited Ticker: PRD
Listed in: London (FTSE Small Cap) Business: Investment Entities
More information: Digital Look / Google Finance
Official Site: Prodesse Investment

Key numbers for Prodesse (18/12/08)

Share price: 266.50p
Market cap: £83 million
Total assets: £1096 million
Net Asset Value per share: 351p
High/low (12 months): 448.50p / 266.50p
Yield: 16.2%

Summary of Prodesse’s business

First off, for this write-up of Prodesse I’m repeating my usual warning, with underlining: I am not an advisor, nor an expert. This is my amateur analysis of Prodesse, for your entertainment only.

Prodesse looks a very risky share, and it’s hard for professionals let alone amateur investors to assess its true value. It is an investment trust that buys AAA mortgage-backed securities (MBS) in the US, principally those of Fannie Mae and Freddie Mac.

If alarm bells aren’t already going off, they should be. The collapse of confidence in MBS market is what triggered the global credit crunch.

Prodesse only invests in top-rated MBS, but half of the problem has been nobody fully believes these ratings anymore, hence MBS have been marked down significantly. Besides cutting off the main source of money for mortgage lending (which caused Northern Rock to fail), this has also forced banks to declare huge write-downs on their devalued assets, and to return to the market for recapitalization.

(The other half of the problem are the lower-rated ‘sub-prime’ mortgages that are defaulting in huge numbers).

It all looks a toxic soup to wade into, but a couple of years ago MBS seemed a very boring investment. That’s exactly why so many institutions around the world ended up with MBS on their books.

It’s not even like Prodesse was set up to make spectacular returns. According to the company FAQ:

The investment objective is to achieve distributable income yield on net assets (in US dollar terms) of at least 3.5% greater than the yield on the ten-year US Treasury on an annualised basis while preserving net asset value (in US dollar terms) over the long term.

Prodesse aimed to make up these returns through leverage. You’ll note from the key numbers above that the assets under management is over £1 billion, while the company has a market cap of less than £100 million.

You’ll also notice that:

• Prodesse is apparently trading for 25% less than its asset value per share
• It is yielding over 16%

What this tells me, particularly the huge yield in excess of Prodesse’s target, is that the market is skeptical about Prodesse’s business model. Hardly shocking news; these are mortgage backed securities we’re talking about. Hiring six-year old boys to sweep chimneys would probably be less controversial right now.

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The ever fantastic economics blog The Big Picture has reprinted an interesting letter from John Mauldin, the best-selling US investment writer, in which he details the odd things going on in the markets.

Like most private investors I can’t pretend to understand all of it, but it does reinforce that these times really are as unusual as they feel.

In my view, the apparent breakdown in orderly pricing means it’s either the opportunity of a century, or the storm-before-the-storm. Mauldin writes:

There are things in today’s markets that are simply astounding. They should not exist, yet they do. Why should US bills trade at negative interest? How can oil be trading at all-time highs in terms of spreads over the next year? Bank debt and bonds are trading at discounts not to be believed. Want some free money? I show you a trade that gives you (almost) just that. Fed funds at zero? Are we starting to push on a string?

I’ll pick out a few highlights showing how strangely various markets are priced.

On US treasuries:

In the last few weeks we have seen 30- and 90-day US Treasury bills trade every now and then at a rate of negative interest. That means someone is willing to pay for the privilege of having their cash in US Treasuries. This simply should not be. Why would anyone want to do this? Is this a sign the system is broken? Are we that scared?

My assumption is it does reflect extreme risk aversion; I’ve written before even longer term treasuries are offering crazy low yields.

On corporate bonds:

The corporate bond market is assuming an Armageddon Scenario. Barclays Capital writes that one would have to assume that US GDP will contract by 15% to make sense of the current bond spreads.

On oil futures:

When oil was at $147, the spread was an average of $3.25, or about 2.5%. You can buy January 09 crude futures at a stunning 34.5% lower than January 2010. That means if you could find a place to store that oil, you could lock in a guaranteed 34% profit, less the cost of storage. Sounds like easy money. This is just something that shouldn’t be.

Buying oil futures is a specialist way to invest in oil, let alone buying the oil itself, but the takeaway is simple enough – another apparent case of market breakdown.

On the Federal Reserve’s battle with the credit crunch:

We are getting to ready to run a grand experiment on many theories in the world of economics. Will Ben and Hank get it precisely right? And what is precisely right? Does the avoidance of a second Great Depression mean success? Will anyone be grateful? We all have seen pictures of Paulson looking so very tired and worn. I actually feel sorry for him. Who would want that job?