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There is still opportunity in mortgages: Top hedge fund

Deepak Narula, who runs a group of real estate hedge funds, told CNBC on Thursday that there is still "plenty to do" in the mortgage market, despite rising rates and an impending taper of the Federal Reserve's asset purchase program.

Narula's hedge fund, Metacapital, invested heavily in agency mortgages months before the credit crisis, building one of the most successful hedge funds on Wall Street. His Metacapital Mortgage Opportunities Fund launched in July 2008, and since then, has returned more than 500 percent.

Narula told "Squawk on the Street" that right now, September Fed tapering is currently priced into the market and he didn't expect how reactive the market was to ebbs and flows surrounding news of Fed taper expectations.

(Related: Fed taper impact unclear, volatility certain: StanChart)

"The market's reaction has surprised us a lot. It tells you how much risk there was in the market betting on the Fed's presence," he said. Specifically, many of the long-duration trades and carry trades that were unwound in the second quarter showed that there was a significantly large volume of trades that hinged on Fed actions.

"The reaction was quite violent ... things have stabilized since then, but certainly Q2 was an eye-opener" that took out some of the more speculative trades, he said.

Deepak Narula
Jacob Kepler | Bloomberg | Getty Images
Deepak Narula

"The markets are certainly budgeting that there will be a taper in September," Narula added, because Fed Chairman Ben Bernanke will likely look to begin the process of winding down quantitative easing before his term is completed.

Narula said that his firm's view is that when the Fed begins the taper process, it will step back more significantly in its buying of Treasury securities than in mortgage securities.

If the taper is delayed, he said that investors can expect a short-term pop in prices for both Treasurys and mortgage securities.

(Narula in January: Mortgage Assets Still Good Buy)

In the housing market, Narula pointed out that mortgage refinancing is down nearly 70 percent since May, which is troubling since so much economic activity is related to it.


"It's very simple, it's about higher rates," he explained. With mortgage rates closing in on 5 percent, "it's not a surprise that refinancing falls off a cliff."

Despite the trouble in refinancing, the mortgage market is a "very large market with many moving parts in terms of risk," he said.

"There's going to be plenty to do in that market," Narula added, but the "very significant investment opportunities" created by the credit crisis will be difficult to see again without another crisis "which we all hope" doesn't happen.

—By CNBC's Paul Toscano. Follow him on Twitter @ToscanoPaul and get the latest stories from "Squawk on the Street"

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  • Diana Olick serves as CNBC's real estate correspondent as well as the editor of the Realty Check section on CNBC.com.