Interviewee: Jason Steuerwalt
Interviewer: Mike Pacitto
Date: July 24, 2024
Mike:
Hi everyone, I’m Mike Pacitto with iM Global Partner. Thanks for joining us for this quarterly video update on the iM Global Partner Alternative Strategies Fund. I’m joined today by Jason Steuerwalt, Head of Alternatives here at iM Global Partner and co-Portfolio Manager for the fund.
After a brief update on some selected metrics, we’ll dive into each of the underlying strategies for more in-depth commentary on performance, positioning and outlook. Overall this video update should clock in at around 15 minutes. We appreciate your time and hope you find it well-spent.
In terms of allocation, our tactical overweight to the DoubleLine Opportunistic Income strategy remains intact and remains from our perspective very attractive. Jason will get into details on that later. Otherwise, the underlying distinctive orientation of the fund – a diverse group of separate account strategies unique to MASFX with low inter-correlation to each other – continues with six overall managers and strategies.
In terms of performance, you’ll see here that the fund has meaningfully outperformed the Agg Bond index as well as the Morningstar peer group since inception.
That consistent delivery of outperformance has continued so far this year, as MASFX has a sizable outperformance spread over core bonds in both year to date 2024 and in this most recent second quarter.
More specifically this year, the fund is ahead of the Agg bond index by well over 500 basis points through the end of Q2 – and is ahead of the Morningstar category as well, although not by nearly as much – 18 basis points to be exact, but we’ll take it.
Along those lines, while many clients use the fund as a core alternative fund, many other clients do use it more specifically as a diversifier for their bond portfolio. In this respect, the Alternative Strategies fund has really shined – historically since inception beating the Agg Bond index by 227 basis points annualized – while maintaining a similar standard deviation volatility level and yield and very low correlation, thus providing real diversification benefits to bond allocations.
Getting more granular in terms of diversifying benefits against bonds, the fund’s downside average return has been less than a fifth of the Agg during down periods, with over three times the up-capture – so net-net the upside/downside characteristics have been very favorable. This is why we see many consultants and institutional investors continue to like this strategy for immunizing so to speak their bond portfolios.
Okay Jason, a bit more on performance then let’s get more in-depth on the underlying managers and strategies.
Jason:
Thanks, Mike.
6 The Fund was up 1.5% in Q2, resulting in a nice 4.6% return YTD through the first half of the year after a resonable 5.9% gain in 2023. The positive performance has carried over into Q3, with the fund up over 1% through the first two weeks of July.
Again, since many investors use the fund at least in part as a complement to core fixed income, we compare to the Agg, which was just slightly positive in Q2 and still down about 70bps YTD though June. We’re fairly happy about that level of outperformance this year, and I’d note over the trailing 3 years, the fund has beaten the Agg by around 900bps.
As a reminder, the strategy Blackstone (formerly DCI) manages for our fund consists of a long-short market neutral CDS portfolio and a cash bond sleeve that’s predominantly HY, where credit beta and interest rate duration are hedged to low levels. The intention is for individual security selection to drive performance over time rather than rates or credit spreads.
We like this strategy since it adds some diversity in approach, using a systematic, model-driven process, as well as uncorrelated return potential. It was up almost 5% in the terrible market environment of 2022, up almost 8% in 2023, obviously a better market for risk assets. In Q2 it was up about 1.3%, leaving it up almost 3% YTD through June. So it’s done well in negative and positive markets, and continues to chug along.
As we note here, the lower absolute spread level in credit markets somewhat limits the upside since the strategy is market neutral on the CDS side and doesn’t use massive gross exposure to stretch for returns, and the long bond side is hedged to low rate and credit sensitivity.
But since the strategy is relatively defensively positioned, underweight low quality and declining quality names, it should provide good protection in a declining market, with the potential for positive absolute returns. Also worth noting that the dispersion between model-implied credit spreads and market spreads normalized for the absolute spread level is towards the upper end of its historical range, which means there’s a lot of relative mispricing to capture despite what might appear at first glance to be a somewhat meager opportunity set.
As Mike mentioned, we tactically overweighted DoubleLine’s sleeve at the beginning of 2023, on the belief that the return profile was quite asymmetric in our favor. It didn’t work right away, but the portfolio finished up over 9% in 2023 and after a relatively modest 1.2% gain in Q2, it’s up almost 4% so far this year.
Nearly every sector in the Portfolio generated positive returns, primarily the credit-sensitive areas, as spreads generally continued to grind tighter in most sectors, with the top-performing parts of the portfolio consisting of ABS and CLOs. Non-Agency RMBS also contributed nicely, with a continued good performance of the collateral and positive supply-demand tailwinds. Essentially all of the portfolio’s exposure to floating-rate and securitized credit sectors performed well in Q2 as these areas continue to provide high carry in addition to benefitting from credit spread tightening.
Agency mortgage-backed securities and commercial mortgage-backed securities were the only sectors in the portfolio to detract from performance. Agency MBS underperformed due to duration-related price impacts. CMBS also hurt performance as credit spreads didn’t rally as much compared to other fixed income sectors.
The portfolio continues to be heavily weighted toward non-Agency RMBS, at 36%, followed by CLOs at 20%, and CMBS at 17%. Overall, the securitized credit segments represent almost 75% of the portfolio and yield a bit over 10%, while the government backed segments account for almost a quarter of the portfolio and yield almost 6%. Corporates have been reduced due to continued spread tightening and make up less than 2% of the portfolio. As noted, the yield on the portfolio is about 9.2% with a duration of about 5.2.
2023 was a challenging year for this strategy, with a lot of volatility, ending down about 4%. Things turned around dramatically in the first quarter of this year and the strong performance continued into Q2, with gains of about 4.7%, resulting in YTD returns of over 14%. Last quarter was driven by long positioning in equities and the US dollar, and this quarter the currency positioning continued to be a source of strength, producing the majority of profits. Commodities were also positive during the quarter, with very small losses coming from equities and rates.
As we’ve mentioned before, we don’t just view this allocation as “crisis alpha,” but as an uncorrelated source of positive absolute returns that should be additive to performance over time. That said, it should have almost no correlation to equities or bonds long-term, and it should also do well in an extended market dislocation, which is of course a great feature in an alternative strategy.
At quarter end, the portfolio was long equities, although it was mainly long non-US developed markets and a bit of EM, and actually short US equities. It also remained long the USD vs JPY and short against the Euro. Although its given back some gains subsequent to the end of the quarter, the Yen short has been a big driver of performance the last two years. We’re pleased to see this continued strong performance from the strategy in Q2 in strong market for equities, despite the equity part of the strategy being essentially flat.
Again, we’re quite confident the DBi strategy should increase the long-term risk-adjusted returns of the fund because of its diversification, and we also think there’s a good chance it can increase the absolute returns as well. After early struggles, this allocation is performing very well now. It’s going to go through ups and downs, and you obviously can’t predict the timing of when trend following will thrive, but we view it as a strategic allocation and we’re happy to be getting some meaningful benefits from it right now.
FPA was up over 2% in Q2, putting it up almost 7 and a half YTD following last year’s high teens performance.
The biggest contributor to performance was a collection of positions in post-reorganization oil services company McDermott International. The company’s securities have been very volatile (it was collectively the largest detractor last quarter). This is hardly unusual for commodity-adjacent businesses, or for post-bankruptcy companies, so volatility from a company in both those categories is unsurprising.
Alphabet and Analog Devices were the only other contributors of more than 30bps. On the negative side, commercial vehicle dealer Rush Enterprises was the only detractor of more than 30bps, as the stock fell partially due to investor concerns about cyclicals in a potentially slowing economy and the retirement of two senior executives.
Activity was again relatively light during the quarter, with no material increases or decreases of existing positions. There were a couple new long positions added, and a small short in SPY as a hedge. Net long equity exposure is 53%, the lowest in some time. Credit exposure is back into the low teens, at almost 12%. FPA has historically added to credit exposure significantly during periods of market stress, but has found enough unique positions across various market segments to reach a significant position even while corporate credit spreads are quite narrow relative to history. Cash ended the quarter at 33%, a high level, but down several percentage points from the end of the last quarter.
The Absolute Return strategy was up nearly a percent in the second quarter, amid a mixed performance picture for fixed income. That leaves it up about 2.5% through the first half. We think it’s also very attractive, especially considering its relatively conservative positioning. It’s yielding about 7.3% with a duration of just under 4.
As a reminder, compared to DoubleLine, Loomis typically has a larger allocation to corporates vs securitized, owns a bit of yielding equities and convertibles, has significantly less in mortgages (particularly Agency MBS), and will typically hold more dry powder, which usually results in slightly lower yield and duration. So despite the credit-oriented nature of both portfolios, the DL and Loomis approaches and portfolios are pretty different, which has produced complementary return patterns.
The portfolio’s allocation to securitized credit contributed the vast majority of returns for the quarter. Non-Agency CMBS and non-Agency RMBS were the biggest contributors. Securitized remains the largest allocation in the portfolio (33.0%), with ABS, where the portfolio is well-diversified across a range of sub-sectors, making up almost one-third of the securitized book. Non-Agency CMBS is slightly behind that, also at almost one-third. Almost equal allocations to CLOs and non-Agency RMBS make up the rest and those together account for a bit more than a third of the securitized holdings.
IG corporate bonds, bank loans, and convertible bonds were also slightly additive, HY was basically flat, and the small dividend-focused equity allocation was a minor drag on performance. In terms of allocations, IG ended the quarter at about 16% net, HY was about 15% net, and equity, convertible bonds, bank loans, and EM bonds were all under 5% allocations, with about 10% in cash.
The Water Island sleeve of the fund was slightly negative after fees in Q2, resulting a small loss in the first half of the year.
The portfolio is still heavily tilted toward merger arbitrage (almost 85% of long exposure), although there has been an increase in credit special situations. That segment, which has increased to about 15% of the portfolio, contributed positively, but those gains were offset by losses in core merger arbitrage positions.
The top contributor the portfolio for the quarter was a position in the acquisition of Olink Holding by Thermo Fisher Scientific, while the Capri Holdings-Tapestry deal was the largest detractor. There are many examples where maintaining or increasing a position when deal spreads widen but conviction is high is the right move, but Capri is an example of deciding that capital is best used elsewhere when deals get extended for regulatory review and there are plenty of other opportunities at attractive rates of return.
The environment should be conducive to good returns going forward, as M&A volume in North America surpassed one trillion dollars in the first half of 2024, a 27% increase compared to the first half of 2023. Transactions over $10 billion are up almost 70% year-over-year and account for the majority of volume growth in 2024. There has been a lot of strategic dealmaking, and the private equity landscape has also been quite active, with over 50 transactions valued at $500 million or more announced in the second quarter alone. There remains a lot of dry powder in PE funds, and credit is readily available, albeit at a cost. Additionally, the potential for regulatory change in Washington is a potential significant positive catalyst for the strategy.
To return briefly to the Agg comparisons, the fund has beaten the Agg by about 14 percentage points over the last 5 years. Since the fund’s high point at the end of August 2021, the outperformance is about nine percentage points, and since the Agg’s peak at the end of July 2020, the outperformance is about 21 percentage points.
Despite that outperformance, the long-biased fixed income managers in the fund, DoubleLine and Loomis Sayles, still have very attractive portfolios on an absolute basis and obviously relative to the Agg. Between them, there’s a blended yield-to-maturity of almost 9% at quarter end with a duration of under 5. We’ve had some decent contributions from them, but certainly nothing as big as our upside case, which was predicated on earlier rate cuts at the same time as strong credit performance. That’s fine, as we should just realize that performance over a bit longer timeframe, and in the meantime, we’ve gotten strong performance from DBi, FPA and steady contributions from Blackstone. Water Island has been the laggard this year, but we know that absent multiple deal breaks, spreads at these levels are indicate the probability of good returns in coming quarters.
So, at the risk of sounding like a broken record, big picture, we have a healthy yield from DoubleLine and Loomis Sayles, and a really attractive annualized deal spread with relatively short average expected deal duration from Water Island. Collectively, that’s almost 60% of the fund. That’s complemented by the smaller, opportunistic, go-anywhere FPA portfolio that also has significant dry powder, and the very lowly correlated Blackstone and DBi strategies, both of which we’ve seen can continue to do well or even very well in a positive market environment, but have historically protected capital and even generated positive returns in down periods for stocks and bonds.
This is more of an all-weather portfolio than it’s ever been, with the continued tailwind of the overweight to the most attractive credit sectors. We feel good about the performance so far this year, but we think there’s still plenty of runway ahead.
Back to you, Mike.
Mike:
Thanks Jason.
I’ll close here by saying thanks to all of our clients and to our prospective clients for your confidence and interest in the iMGP Alternative Strategies Fund. If you have more questions about the strategy, would like further information or a call with us please don’t hesitate to reach out – just send us an email at: [email protected]