Wednesday, November 16, 2011

What Hedge Funds Can Teach College Students

Some very interesting data on students loan defaults and which type of school makes sense financially in this WSJ article about hedge fund managers investing in student loan pools:

Historically, investors have assumed 25% to 30% of student loans bundled into their bonds will default. But today they are baking in between 30% and 40% default rates among the current crop of graduates, said Chris Haid, a director in asset backed trading at Barclays Capital. Even those assumptions are a best guess and defaults could ultimately go higher if unemployment rises, Mr. Haid said.

This analysis translates into some surprising insights for students and policy makers. For example, in the current economy, it may make more sense to enter a technical college than to go to law school.

Not all lessons from the bond market are so counterintuitive. The most important, in fact, is a slight twist on a maxim most students know from childhood: stay in school, just not too long.

Failure to graduate is the single most important predictor of whether a student will default on loans, which stands to reason since the unemployment rate is 8% for Americans between the ages of 20 and 24 with four-year college degrees, compared to 21% for those without.

Just as important is finishing on time. Investors in bonds backed by student loans hate to see perpetual academics in their portfolio, chronically changing majors or stopping and starting school, adding years of tuition to their debt load.

"When you see a guy in a loan made in 2005 that is still in school, you throw that away," said investor Rubin Bahar, of Eagle Asset Management.

In terms of picking a school, technical colleges may be less prestigious, but their low cost relative to the higher wages they deliver makes them attractive, according to Mr. Ades.

Tuition at public two-year colleges in the U.S. will cost $2,963 a year on average in the 2011 academic year, compared to $28,500 a year for four-year private colleges, according to estimates by non-profit group The College Board.

"It's not just about where you can get the best education," he said during an interview in the Miami Beach office of his hedge fund, Kawa Capital Management. Students should pick schools where the payoff from higher salaries upon graduation exceeds the cost of the education by the widest margin, he contends, especially when the job market contracts.

By that arithmetic, technical colleges come out on top, Mr. Ades said. "We're in a skills based economy and what we need is more computer programmers, more [nurses]," he said. "It's less glamorous but it's what we need."

Law school, on the other hand, can end up a sucker's bet in periods of high unemployment, experts in student loan-backed bonds say.


What Hedge Funds Can Teach College Students


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