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Commentary iMGP High Income Fund First Quarter 2023 Commentary

The iMGP High Income Fund rose 3.20% in the first quarter, outperforming the Bloomberg Aggregate Bond Index (Agg), which gained 2.96%, but slightly trailed high-yield bonds (BofA Merrill Lynch US High-Yield Cash Pay Index), which posted a 3.72% gain. The fund outperformed its Morningstar Nontraditional Bond category peer group, which rose 1.57%.

Past performance does not guarantee future results.  Index performance is not illustrative of fund performance.  An investment cannot be made directly in an index. The investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance of the fund may be lower or higher than the performance quoted. To obtain the performance of the funds as of the most recently completed calendar month, please visit Investment performance reflects fee waivers in effect. In the absence of such waivers, total return would be reduced.

Quarterly Review

Performance of Managers

During the quarter, the two credit managers performed in line with or better than the Aggregate Bond index. BBH gained 2.92% and Guggenheim gained 3.54%. High-yield bonds were up 3.68% in the period. Neuberger Berman gained 3.39% compared to a 6.17% gain for the CBOE S&P500 2% OTM PutWrite benchmark. Specific to Neuberger’s recent underperformance, it is due to a combination of factors. First, the path dependency of the index worked largely in its favor relative to Neuberger’s active, diversified approach, as the dates of the index rolls coincided with fairly high levels of implied volatility (generating good levels of option income) but not significant drawdowns from the last roll date. Over time, we believe Neuberger’s approach of active diversification and risk management tend to work better and Neuberger has meaningfully outperformed since inception. This has been the case as Neuberger has beaten this benchmark since inception with 5.68% annualized return compared to 3.99% for the index. But in any given month, quarter, or even year, a more concentrated, less-diversified, passive strategy can perform better. (All sub-advisor returns are net of the management fees that each sub-advisor charges the fund.)

Manager Commentaries

Brown Brothers Harriman

The BBH sleeve returned 2.92% during the first quarter of 2023. Fixed-income indexes gained during the quarter as longer-term rates declined. Spreads of bonds issued by banks widened, but excess returns in the broader corporate debt markets (investment-grade bonds, senior bank loans, and high-yield bonds) were positive. Indexes of non-traditional asset-backed securities and CLO debt outperformed during the quarter. Agency MBS and commercial mortgage-backed securities (CMBS) underperformed during the quarter. U.S. dollar-denominated emerging-market bonds also lagged during the quarter.

Credit valuations remain broadly appealing. According to our valuation framework, 47% of investment-grade corporate bonds screened as a “buy,” 47% of high-yield corporate bonds screened as a “buy,” and 95% of bank loans screened as a “buy.” These figures increased from their respective levels at the start of the year, when 36% of investment-grade corporate bonds, 46% of high-yield corporate bonds, and 80% of bank loans screened as a “buy.”

Away from the corporate credit markets, we are finding an abundance of attractively valued opportunities in the structured credit markets, particularly among non-traditional ABS issuances, floating-rate single-asset single-borrower (SASB) CMBS, and collateralized loan obligation (CLO) debt.

The portfolio’s 2-year duration contributed to the strategy’s total return as U.S. Treasuries with maturities of one year and greater declined during the quarter. Sector allocation was additive to performance, as holdings of strong-performing sectors, including bank loans, high-yield corporate bonds, and asset-backed securities (ABS), more than offset exposures to weaker-performing sectors. Selection results contributed modestly. Results in high-yield corporate bonds, CMBS, and ABS were positive, while results in loans and investment-grade corporate bonds were negative.

With the intra-quarter volatility in credit spreads, we were able to buy some attractively priced new credits. We purchased a venture debt ABS, a BB-rated corporate bond issued by a REIT, and a loan to a midstream energy company.

At the end of the month, the portfolio’s duration was 2.1 years and remained near levels consistent with long-term capital preservation. High-yield investments represented 54%, were comprised primarily of credits rated BB. The portfolio’s yield to maturity was 10.2% and remained elevated versus bond market alternatives. The portfolio’s option-adjusted spread (OAS) was 588 basis points; for reference, the Bloomberg U.S. Corporate Index’s OAS was 138 basis points, and the Bloomberg U.S. Corporate High Yield Index’s OAS was 455 basis points at month-end.

Guggenheim Investments

We continue to believe the economy is on track for a recession this year. Helped by lower energy prices, warm weather, and easier financial conditions, real economic growth reaccelerated over the past few months. However, we continue to see a high probability of a recession starting later this year.

The Fed is explicitly targeting a weaker labor market, and several leading indicators point to rising unemployment later this year. Our analysis shows that employment levels have caught up to GDP, which should ease the need for “labor hoarding”. Consumption also faces headwinds from dwindling excess savings buffers and a negative wealth shock as financial asset and home prices fall.

The fallout from recent regional bank failures is ongoing. Recent data shows some signs of stabilization indicating reduced risk of an acute crisis, but we expect a further tightening in bank lending standards resulting in a slowdown in credit growth. Business investment is likely to slow further as a result. Because private sector balance sheets are generally healthy in aggregate and the economy lacks major imbalances, we do not expect a particularly deep recession. But the likelihood of a limited monetary and fiscal policy response means the economic recovery will likely be weak.

While goods prices could see a near-term rebound, inflation should trend lower over the year, helped by shelter inflation cooling. Services inflation outside of shelter is the main concern for the Fed, but a softening labor market and slowing wage growth should gradually bring this category down as well. We expect core inflation will end the year around 3% and fall close to 2% in 2024.

We think the Fed will proceed more cautiously, but additional tightening is needed. Resilient labor market data and services inflation mean the Fed is not convinced their job is done. At the same time, concerns over the lags of monetary tightening and banking sector stability argue for a more cautious approach to policy. We see two more 25 basis point hikes after which the Fed will be on hold.

The Fed is wary of letting financial conditions ease too far and too fast, which would undo the economic impact of their aggressive rate hikes. Even as they pause rate hikes, they will maintain a hawkish rhetoric and try to keep rate hikes on the table. Fed communication has made it clear they are aware of elevated recession risk, but they see the risks of letting inflation expectations become unanchored as far more dangerous. Fed policy is unlikely to pivot to rate cuts as quickly as in the past, even amid rising unemployment.

Despite recession risk, major fiscal stimulus is unlikely given inflation concerns. A divided government virtually ensures policy gridlock for the next two years. We expect the debate over raising the debt ceiling will get pushed to the last minute and lead to market volatility. The end result is likely to be government spending cuts, further pressuring economic growth.

From a portfolio-position perspective, we have been turning more defensive, but remaining opportunistic, as the credit cycle reaches an inflection point. As the economic cycle rolls over this year, Treasury yields should see a significant decline, but are unlikely to return to the lows of the last cycle. Recent bank failures are evidence that pockets of distress are likely to emerge given the lagged effect of monetary policy.

The emergence of a recession presents downside risk to equity and high beta credit this year. Corporate fundamentals remain solid, but investors should remain selective as downgrades and defaults increase in the next 6-12 months. We are finding attractive value in high-quality corporate and structured credit, and are reducing exposure to bank loans. Attractive yields provide an income cushion that could reduce the impact if spreads should widen from here. At quarter end, the portfolio’s yield to maturity was 9.7%, with an effective duration of 2.4 years.

Neuberger Berman

As if trying to remind investors of their unpredictability, broad-based equity and fixed-income markets posted healthy gains over the quarter in the face of the unexpected collapse of Silicon Valley Bank (SVB), which sparked U.S. regional banking contagion fears (e.g., $30 billion injection into First Republic Bank) and UBS’s government orchestrated absorption of Credit Suisse. In simple terms, markets seem to have entered the ‘bad news is good news and strong economic results is bad news’ phase of the U.S. Federal Reserve rate cycle. The on-going tug-of-war between expectations for continued interest-rate increases to fight inflation and the risk of pushing the U.S. economy into a recession seems to be tilting towards the latter. We believe financial markets are returning to historically ‘normal’ dynamics with ‘zero-rate’ policies a thing of the past barring some exogeneous events (e.g., pandemic, war, natural disasters) that require extraordinary measures. The more likely return drivers over the next few years seem to be non-zero rates, company margin durability, leveraged balance sheets, rising commodity and labor prices, geo-political uncertainty, social unrest, and global trade disruptions. One might argue this list is somewhat evergreen. Yet, we feel the accommodative flexibility and coordination of global monetary authorities that has helped inoculate many economies and global trade from disruptions has ‘left the building’. In short, durable capital formation will likely be harder going forward than it has been since the 2008/09 Global Financial Crisis. Conveniently, we believe this could support the case for diversifying strategies, like option-writing, that have the potential to offer structured return payoffs.

The U.S. Federal Reserve Board of Governors raised its target rate 50bps during the quarter to 5.0%. However, increased concerns over financial conditions resulted in a lowering of expectations for the magnitude of future rate increases, which was a positive for risk assets. Over the quarter, the S&P 500 Index rallied 7.50%, the Cboe S&P 500 2% OTM PutWrite (“PUTY”) jumped 6.17%, and the Cboe Russell 2000 PutWrite (“PUTR”) rose 0.32%.

US Treasury Markets

The bad news in the quarter was ‘great’ news for fixed income markets with the Bloomberg US Aggregate Bond Index and the Bloomberg US Corporate High Yield Index rallying 2.96% and 3.57%, respectively. Short-term US Treasury index returns anticipated a potentially more accommodative Fed in late 2023 as the ICE 20+ Year US Treasury Index gained 6.45% as 10-Year interest rates fell -40bps. The shorter duration ICE BofA 0-3 Year US Treasury Index rose 1.42% in the quarter. In general, gains in US Treasuries helped our strategies regain a portion of collateral losses suffered in 2022. On the quarter, short-term US Treasury Rates (3M US T-Bill) were up 38bps and the long-term rates (10Y US Treasury) declined -41bps.

Option Implied Volatility Indexes

Despite the SVB crisis, implied volatility levels declined across markets during the quarter. The relatively ‘behaved’ response of option markets, the VIX Index, to the SVB crisis suggests that higher levels of volatility have priced in ‘unexpected’ events. Given the events of the first quarter, we believe they are likely to continue to do so. For the month, the Cboe S&P 500 Volatility Index (“VIX”) was down -2.0 pts with an average 30-day implied volatility premium of 2.9. Further, the Cboe Russell 2000 Volatility Index (“RVX”) was down -0.7 pts with an average implied volatility premium of 0.6. For the quarter, VIX fell -3.0 pts yielding an average 30-day implied volatility premium of 3.3. Accordingly, RVX declined -1.0 pts resulting in an average implied volatility premium of 2.5.

Strategy Allocations

The fund’s target allocations across the three managers are as follows: 40% each to Brown Brothers Harriman and Guggenheim Investments, and 20% to Neuberger Berman. We use the fund’s daily cash flows to bring each manager’s allocation toward their targeted allocation should differences in shorter-term relative performance cause divergences.

Sub-Advisor Portfolio Composition as of March 31, 2023

Brown Brothers Harriman Credit Value Strategy
Bank Loans36%
Corporate Bonds32%
Guggenheim Multi-Credit Strategy
Bank Loans13.7%
Corporate Bonds26.6%
CMBS (Non-Agency)3.4%
Preferred Stock3.2%
RMBS (Non-Agency)7.3%
Neuberger Berman Option Income Strategy
Equity Index Put Writing  100%

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Dividends, if any, of net investment income are declared and paid monthly. The Fund intends to distribute capital gains, if any, to shareholders on a quarterly basis. There is no assurance that the funds will be able to maintain a certain level of distributions. Dividend yield is the weighted average dividend yield of the securities in the portfolio (including cash). The number is not intended to demonstrate income earned or distributions made by the Fund.

Though not an international fund, the fund may invest in foreign securities. Investing in foreign securities exposes investors to economic, political and market risks, and fluctuations in foreign currencies. Investments in debt securities typically decrease when interest rates rise. This risk is usually greater for longer-term debt securities. Investments in mortgage-backed securities include additional risks that investor should be aware of including credit risk, prepayment risk, possible illiquidity, and default, as well as increased susceptibility to adverse economic developments. Investments in lower-rated and non-rated securities present a greater risk of loss to principal and interest than higher-rated securities. Derivatives may involve certain costs and risks such as liquidity, interest rate, market, credit, management, and the risk that a position could not be closed when most advantageous. Investing in derivatives could lose more than the amount invested. The fund may invest in master limited partnership units. Investing in MLP units may expose investors to additional liability and tax risks. Multi-investment management styles may lead to higher transaction expenses compared to single investment management styles. Outcomes depend on the skill of the sub-advisors and advisor and the allocation of assets amongst them. The fund may make short sales of securities, which involves the risk that losses may exceed the original amount invested. Merger arbitrage investments risk loss if a proposed reorganization in which the fund invests is renegotiated or terminated.

Diversification does not assure a profit nor protect against loss in a declining market.

Asset-backed security (ABS) is a financial security collateralized by a pool of assets such as loans, leases, credit card debt, royalties or receivables.

A basis point is a value equaling one on-hundredth of a percent (1/100 of 1%)

Below Investment Grade bond is a bond with a rating lower than BBB.

Collateral is something pledged as security on a loan to be forfeited in the event of default.

Collateralized put-write is an options trading strategy that involves short positions in put options and the use of the underlying stock as collateral.

Contango is a situation where the futures price of a commodity is higher than the spot price.

A coupon or coupon payment is the annual interest rate paid on a bond, expressed as a percentage of the face value and paid from issue date until maturity.

Distribution yield:  The trailing twelve month (TTM) income distribution yield is the sum of a fund’s total trailing interest and dividend payments divided by the last month’s ending share price (NAV).  12-Month Yield gives you a good idea of the yield (interest and dividend payments) the fund is currently paying.  The trailing twelve month (TTM) total distribution yield is the sum of a fund’s total trailing interest and dividend payments plus capital gains distributions divided by the last month’s ending share price (NAV).  12-Month Yield gives you a good idea of the yield (interest and dividend payments and capital gains) the fund is currently paying.

Duration is a commonly used measure of the potential volatility of the price of a debt security, or the aggregate market value of a portfolio of debt securities, prior to maturity. Securities with a longer duration generally have more volatile prices than securities of comparable quality with a shorter duration.

Floating interest rate, also known as a variable or adjustable rate, refers to any type of debt instrument, such as a loan, bond, mortgage, or credit, that does not have a fixed rate of interest over the life of the instrument.

Futures are derivative financial contracts that obligate parties to buy or sell an asset at a predetermined future date and price

Investment grade bond is a bond with a rating of AAA to BBB

Mortgage-backed security (MBS) is a type of asset-backed security that is secured by a mortgage or collection of mortgages.  Commercial Mortgage Backed Securities are backed by mortgages secured by commercial real estate.  Residential Mortgage Backed Securities are backed by mortgages secured by residential real estate.

Options are a financial derivative sold by an option writer to an option buyer. The contract offers the buyer the right, but not the obligation, to buy (call option) or sell (put option) the underlying asset at an agreed-upon price during a certain period of time or on a specific date.

Barclays Aggregate U.S. Bond Index is a market capitalization-weighted index, meaning the securities in the index are weighted according to the market size of each bond type. Most U.S. traded investment grade bonds are represented. The index includes US Treasury Securities (non-TIPS), Government agency bonds, Mortgage backed bonds, Corporate bonds, and a small amount of foreign bonds traded in U.S

The Bloomberg.  Credit Index is an unmanaged index that includes strategies with exposure to credit across a broad continuum of credit sub-strategies, including Corporate, Sovereign, Distressed, Convertible, Asset Backed, Capital Structure Arbitrage, Multi-Strategy and other Relative Value and Event Driven sub-strategies.

The Bloomberg US non-Agency Commercial Mortgage Backed securities (CMBS) Index ) Index is the Non-Agency CMBS components of the Bloomberg US Aggregate Bond Index, a market value-weighted index that tracks the daily price, coupon, pay-downs and total return performance of fixed -rate, publicly placed, dollar denominated, and non-convertible investment grade debt issues with at least $300 million par amount outstanding and with at least one year to final maturity.

ICE BofA AA-BBB Miscellaneous Asset Backed Securities (ABS) Index tracks the subset of the ICE BofA US Fixed Rate Index rated AA to BBB and includes all ABS collateralized by anything other than auto loans,, home equity loan, manufactured house, credit card receivables and utility assets.

The CBOE Russell 2000 PutWrite Index (PUTR) is designed to track the performance of a hypothetical strategy that sells a monthly at-the-money (ATM) Russell 2000 Index put option.

The CBOE Russell 2000 Volatility Index (RVX) is a key measure of market expectations of near-term volatility conveyed by Russell 2000® Index (RUT) option prices. The RVX Index measures the market’s expectation of 30-day volatility implicit in the prices of near-term RUT options traded at CBOE.

The CBOE S&P 500 PutWrite Index (ticker symbol PUT) is a benchmark index that measures the performance of a hypothetical portfolio that sells S&P 500 Index (SPX) put options against collateralized cash reserves held in a money market account.

The CBOE S&P 500 2% OTM PutWrite Index (PUTY℠ Index) is designed to track the performance of a hypothetical passive investment strategy that collects option premiums from writing a 2% Out-of-the Money (OTM) SPX Put option on a monthly basis and holds a rolling money market account invested in one-month T-bills to cover the liability from the short SPX Put option position.

ICE BofAML 0-3 Year U.S. Treasury Index tracks the performance of U.S. dollar denominated sovereign debt publicly issued by the U.S. government in its domestic market with maturities less than three years.

ICE BofA Merrill Lynch 1-3 US Year Treasury Index is an unmanaged index that tracks the performance of the direct sovereign debt of the U.S. Government having a maturity of at least one year and less than three years.

The ICE BofAML U.S. High Yield TR USD Index is an unmanaged index that measures the performance of short-term U.S. dollar denominated below investment grade corporate debt publicly issued in the U.S. domestic market.

The MSCI EAFE Index measures the performance of all the publicly traded stocks in 22 developed non-U.S. markets

The MSCI Emerging Markets Index captures large and mid-cap representation across 24 Emerging Markets (EM) countries. With 845 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in each country.

The Russell 2000 Index measures the performance of the 2,000 smallest companies in the Russell 3,000 Index.

The S&P 500 Index consists of 500 stocks that represent a sample of the leading companies in leading industries. This index is widely regarded as the standard for measuring large-cap U.S. stock market performance.

VIX is a trademarked ticker symbol for the Chicago Board Options Exchange Market Volatility Index, a popular measure of the implied volatility of S&P 500 index options. Often referred to as the fear index or the fear gauge, it represents one measure of the market’s expectation of stock market volatility over the next 30 day period.

You cannot invest directly in an index.

Credit ratings apply the underlying holdings of the fund, and not to the fund itself. S&P and Moody s study the financial condition of an entity to ascertain its creditworthiness. The credit ratings reflect the rating agency’s opinion of the holdings financial condition and histories. The ratings shown are all considered investment grade and are listed by highest to lowest in percentage of what the fund holds.

Mutual fund investing involves risk. Principal loss is possible.

iM Global Partner Fund Management, LLC has ultimate responsibility for the performance of the IMGPFunds due to its responsibility to oversee the funds’ investment managers and recommend their hiring, termination, and replacement.

The IMGP are Distributed by ALPS Distributors, Inc. LGM001317 Exp. 7/31/2023