A shift to concentrate on real estate debt including mortgages backed by residential and commercial property by listed hedge fund Cheyne Capital's Real Estate Credit Investments (RECI) has paid off.

The fund posted a 7% rise in value and a 48% jump in profits in the last quarter of 2010.

Over the period RECI's shares rose 25% to a 29-month high of €1.24 ($1.72) driven largely by retail investors who have also been the primary drivers of a daily turnover of 100,000 shares.

RECI also posted its sixth consecutive quarterly profit, at €4.6 million ($6.4 million), up from €3.1 million ($4.3 million) in the quarter to September 30, 2010.

Investors can buy preference shares, maturing in December 2017 with an 8% coupon covered 2.3 times or ordinary equity with a 5% dividend yield, currently trading at a 30% discount to net asset value (NAV). This is tighter than the 40% discount to NAV on September 17, 2010.

The fund, formerly called Queen's Walk Investment and managed by Cheyne Capital's Shamez Alibhai, is selling down its book of small and medium enterprise (SME) loans, UK and European mortgages. These generated cash of €5.8 million ($8.1 million) in the final quarter of 2010 compared with €3.7 million ($5.1 million) the previous quarter. This result also easily outdid the manager's forecast cashflows in December.

RECI raised about €27 million ($37.5 million) fresh capital in September 2010 and in the last quarter of the year spent €21 million ($29.2 million) on new residential debt securities. By February 28, 2011 it had spent a further €13.2 million ($18.3 million) for the real estate debt portfolio.

This portfolio holds bonds at a fair value of €68.3 million ($94.8 million) and a weighted average yield to maturity of 13.2%.

The value of its real estate debt portfolio gained 6.5% in value in the fourth quarter of 2010. These investments now represent 52.4% of its total assets.

Alibhai said market liquidity and opportunities would govern how rapidly residual assets would be sold off. Any profit would be recycled into the real estate debt portfolio.

He sold at a profit in January one legacy portfolio mainly comprising UK mortgages.

"Our investors appreciate the transparency around the bond portfolio, whose value is marked to market. There is also greater liquidity relative to the legacy portfolio though right now, the strategies are doing well and complementing one another," explained Alibhai.

RECI is building its new remit where values are marked to market. It will make approximately two-thirds of new investments in bonds backed by commercial real estate in the form of commercial mortgage-backed securities (CMBS) and one third in similar securities backed by residential mortgage-backed securities (RMBS).

Alibhai said around €500 billion ($694 billion) of refinancing of European commercial real estate will fall due over the next three years. "So there will be stress, and opportunities. There will be people who do not understand the real estate space and dynamics, and they will sell holdings. Also, there are still a lot of motivated sellers looking to reduce their holdings in asset-backed securities," he added.

RECI is the sole listed hedge fund in Europe that gives investors a chance to exploit dislocation in Europe's real estate debt market