Presenters: Litman Gregory Research Team: Jason Steuerwalt, Jeremy DeGroot and Jack Chee
Moderator: Peter Sousa
Date: September 24, 2018
PS: Good afternoon! Thank you all very much for attending today’s webinar to announce the launch of the Litman Gregory Masters High Income Alternatives Fund.
My name is Peter Sousa. I’m the director of portfolio strategies with Litman Gregory, and I’ll be hosting today’s call.
Before we begin, I wanted to announce a couple of housekeeping items. First, the format of today’s webinar will be a q-and-a with the Litman Gregory Research Team / portfolio managers of the High Income Alternatives Fund. We will open with questions submitted by you prior to the call before ultimately opening it up to a live q-and-a session.
For those of you who have only dialed in by phone, you will not be able to ask live questions, since your lines are on “mute.” You’ll need to join the Go-To webinar online to type and submit questions using the desktop control panel.
A replay of today’s webinar will be available on the Litman Gregory Masters Funds website at www.MastersFunds.com. The replay will be available shortly.
Without further ado, let’s get started.
We are very excited to announce the launch of the Litman Gregory Masters High Income Alternatives Fund. The fund will be available for purchase beginning on Friday September 28th and will trade under the ticker MAHIX for the institutional shares, and MAHNX for the investor shares.
It’s not every day that Litman Gregory launches a new fund. The last time we did this was seven years ago when we launched the Masters Alternative Strategies Fund. We’ve been very pleased with the Alternative Strategies Fund, and believe that it has added a lot of value for our shareholders. We’re just as excited about the opportunity for the High Income Alternatives Fund to do the same.
Joining me today are three members of the Litman Gregory Research Team, and the co-portfolio managers for the Masters High Income Alternatives Fund.
Jeremy DeGroot is the chief investment officer and a principal for Litman Gregory. Jack Chee is a senior research analyst and also a principal. Finally, we have Jason Steuerwalt who is a senior research analyst. Jeremy, Jack and Jason are also the co-portfolio managers for the Masters High Income Alternatives Fund. Welcome, gentlemen.
Jeremy, why don’t we start things off with you? Would you mind or could you please give us an overview of the Masters High Income Alternatives Fund?
JD: Be happy to, Peter. I wanted to thank everyone for your time today. As Peter said, we’re really excited to be launching this fund. It’s been many years I guess in the creation process, and we hope to give you a good idea of what the fund’s all about, today.
The first slide here just hits some key points. We’ll be reiterating these, I think, as we go through the presentation today.
But at the very topline, the fund’s goal is to generate a high level of income, consistent with capital-preservation and growth over time. As with our other Litman Gregory Masters Funds, the High Income Alternatives Fund is a multi-manager subadvised fund, where each manager runs a distinct and separate account portfolio specifically for our fund.
This is not a fund-of-funds. You can’t replicate our fund by combining existing public funds run by these managers.
Each of the four income-oriented strategies on the fund is distinctive in its investment approach and opportunity set. Each manager was selected based on Litman Gregory’s intensive due-diligence, and ultimately our conviction in their skill, experience and ability to achieve their individual strategy objectives.
We also believed that we could offer the fund at a very competitive fee; particularly given the quality of the manager lineup.
I wanted to just step back a moment here and talk a bit more of why we created the fund. As I said, our thinking about this started several years ago.
Litman Gregory has been investing in income-oriented funds and strategies that go beyond traditional core investment-grade bonds for many years, improving the return potential and diversifying risks in the overall portfolio
They’ve been particularly valuable during the period since the financial crisis.
We expect these non-traditional strategies to continue to play an important role in our portfolios, as we navigate future interest-rate and credit cycles and the related risks.
Given our experience and our expertise in this area, and critically our access to managers that we believe are among the best in the business, we felt we could built a high-quality, distinctive, high-income fund that we individually would want to invest in and that we’d be highly confident of owning in our client portfolios. Putting our money where our mouth is.
Each of the underlying strategies on the fund is run by experienced opportunistic investors who critically are also strong risk managers in our view. This isn’t a fund that’s chasing yield. These members aren’t just chasing yield for the sake of yield, by any means. That was really important as we thought about constructing and creating this fund.
The managers and strategies on our fund do provide access to non-traditional sources of income, and less-efficient areas of the markets that clients may not otherwise own. High Income Alternatives is why we included the word, “Alternatives.” It’s thinking about these sources of income as being from less-traditional, less-efficient areas of the market, where investors and clients and shareholders may not have any exposure or have very little exposure.
When you put these strategies together in a single fund, we have a diversified portfolio of investments that we believe should generate attractive income and yield over time. Consistent with capital-preservation and prudent risk-management.
Turning to the next slide. What is the risk/return profile of the fund?
Critically here, we have the term, “Over a full market cycle.” These are our targets of what the fund seeks to achieve over market cycles.
We’re targeting income and returns significantly higher than core investment-grade bonds. By investment-grade bonds, we’re measuring that as the Bloomberg Barclays Aggregate Bond Index.
We expect, though, significantly higher returns with lower correlation and less interest rate risk than the Barclays Aggregate Bond. That’s going to be stemming from the managers’ flexibility in their mandates and in their ability to manage duration, specifically.
We expect the fund’s volatility will be higher than the investment-grade bond index.
We believe the fund’s returns will be competitive with or comparable to high-yield bonds over time, but the fund will have lower volatility and downside risk because of the diversified sources of return and the manager flexibility.
The fund’s correlation to high-yield bonds may be relatively high, but we expect significantly lower beta to that high-yield bond index. Given the flexibility of the managers’ mandates, we expect that correlation to vary over time — depending on the market environments and the managers’ positioning.
Hopefully that gives some broad background, and I’ll turn it back to you, Peter.
PS: Perfect. Thank you so much, Jeremy. Really appreciate all of the detail.
Jack — this next question is for you. Really, with all the Masters Funds, the key is finding high-quality managers to execute the strategy. Can you talk about where you focused your efforts when researching strategies and managers for the High Income Alternatives Fund?
If we turn to I think it’s Page 8, I’ll just give some background, here.
When we started to explore the idea of a higher-income fund, we started by throwing out a pretty wide net to a lot of firms that we already know and respect. We also reached out to a number of firms that we were less familiar with.
What we ultimately wanted was to find really high-conviction managers that were experienced and successful investing in higher-income parts of the market. But importantly, I think as Jeremy pointed out in some of his opening comments, we weren’t just looking for managers that were swinging for the fences in order to achieve higher levels of yield. Rather, they were looking to maximize yield within the context of a risk-reward framework.
We also wanted to incorporate some strategies that utilize flexible approaches, providing them the ability to navigate changing economic interest rate and credit market conditions.
One thing we also did was look to maximize the strategies where we could. Like in the case of Guggenheim, for example. We’d been investors in one of their public funds. But here, we thought to minimize some of the constraints imposed on them by stand-alone public funds and gain greater access to some of their best ideas.
Another important point is that we wanted strategies that were complementary to each other, while providing access to skilled investors across various asset classes. Again, with varying levels of exposure to interest rate or credit-rate risk.
One thing that was also important — as Jeremy mentioned, too — was partnering with managers who would have attractive fees. There was a wide range of things that we were looking for in terms of selecting managers for this fund.
PS: Perfect. Appreciate it, Jack.
Sticking with you, since you did such a great job — if you want to get us started, we’ll go into a little bit more detail on each of the underlying strategies and managers on the fund.
Jack, do you want to get us started and focused on two of the more credit-oriented strategies that we currently have on the fund?
JC: Yes. Sure. I’ll start with Brown Brothers who’s running a credit-value strategy for us. Brown Brothers runs an absolute-oriented strategy that invests across a wide range of sectors. But the real focus for them is on asset-backed and corporate securities.
Then within these segments of the market, the emphasis is on what I’d say is our cuspy credit qualities, or those on the dividing line between investment-grade and below-investment-grade.
There are a couple of reasons they focused on these credit-qualities. The first being that over time, these segments have generated attractive excess-returns, along with low default-rates and limited drawdowns.
Second, because these credits are in the crossover territory and subject to upgrades or downgrades, opportunities can arise for [various] reasons. For example, where an index or even an actively-managed strategy can be forced to sell a security as it moves from one categorization to another. This creates a disconnect between fundamentals and valuation.
The idea really behind this Brown Brothers process is through active management to enhance the already-attractive characteristics of these credit-quality segments — as well as to take advantage of volatility that can pop up.
BBH does, however, have the flexibility to invest in lower-rated securities, should the attractive opportunities present themselves.
PS: Can you take a minute and just talk about what they look for at the credit level?
JC: Sure. If we flip the slide to Page 12, fundamental research is really the foundation for Brown Brothers investment process. What you see on this slide are the four pillars that the team requires. Durable operating model — effective management — attractive or appropriate structures — as well as transparency.
Just real quick, I’ll give you one or two sentences about each of these.
Durable credit is one where the team believes an issuer can withstand a really wide range of economic or even regulatory scenarios. An important piece that I’d highlight here is that BBH utilizes a lot of stress-testing, where they first develop what they believe are conservative baseline assumptions for a credit.
Then they require a security to hold up to significantly worse scenarios without resulting in any impairments to the principle and interest.
When assessing management, the team looks for issuers with a long proven track record of execution. Especially through a downturn. Looking for a commitment to capital-market access and incentives that are aligned with creditors’ interests.
With regard to the bottom-left section — appropriate bond structures. The team requires revenues that comfortably support ongoing operations in the capital structure, and that have appropriate maturities and covenant protection.
Then lastly for the transparency. The team demands detailed and timely information of collateral performance — to evaluate and understand the issuer and the credit.
PS: Thanks, Jack.
Can you give a quick comment on portfolio construction?
JC: Sure. This is really just a best-ideas portfolio. The BBH team doesn’t really derive a false sense of security from diversification. They get their sense of comfort just from credit-underwriting, as well as the valuations that they’re buying as credits.
The portfolio has about 80-or-so issues, and it’s spread across even fewer obligors; probably in the 50-to-60 range; making this a relatively concentrated and best-ideas portfolio. For some perspective, the top-10 credits probably account for 20 to 25% of the assets.
They tend to own securities for the long-term and position size is mostly a function of the valuation, with a larger position size limited to around 3% for this strategy.
Then lastly, if we could flip to the next page — Slide 13 —
This is just showing some of the opportunity set that BBH is searching in. Just for real quick context — that red triangle/square thing is the Bloomberg Agg. You can just see that’s yielding just above 3% with a 6-year duration.
Bank loans — ABS — CMBS and corporates are the big main pools that BBH is going to fish in. You can see you’re getting better yields with — in some cases — just half to even less or a fraction of the interest rate risk in their pool.
Hopefully this slide starts to paint a picture of the opportunity set that the fund is looking for.
JD: I believe those are diamonds.
PS: Yes. Diamonds.
Jack: Those square things?
JD: Geometry wasn’t your strong point.
Let’s move on to the next manager. Guggenheim.
JC: Yes. Sure.
Guggenheim runs an unconstrained income-focused strategy. It looks to generate strong risk-adjusted returns across all market environments. It’s not constrained by duration, sector, credit-quality. It can even invest across an issuer’s capital structure.
Typically, what you’ll see in their sleeve are securities in sectors that are outside of the Agg benchmark.
As far as the process, I think I’d highlight that active management is really a hallmark of their investment process, with a constant focus on balancing the risk-reward.
The portfolio’s asset-allocation is constantly evaluated from a number of different directions. This includes a macro top-down view — bottom-up perspectives from a deep credit team. And a dedicated portfolio-construction group. Even the portfolio management team.
This groups at Guggenheim are constantly working together to identify the best relative-values. Then they’ll tactically adjust the portfolio to take advantage of changing macroeconomics and/or credit-market conditions.
If you’ll flip to Page 16, I think, here are some of the key aspects of the investment process that you’ll see. They can kind of speak for themselves, but there’s the macro assessment. There’s a relative value focus. There’s an opportunity set and then there’s just the risk-management.
Just in terms of their investment process, one of the key dials that you’ll see Guggenheim turn up and down is their exposure to credit. Specifically in areas such as high-yield bonds.
If we turn to Page 17, at the bottom, you’ll see a table. These are some of the portfolio-construction postures. Then to the right, there are some asset classes that typically fit into each of those buckets. What you can expect is that in bullish environments, the team will dial up credit-risk, as well as exposure to sectors with higher beta to the credit markets. And vice-versa if they were more concerned and defensive.
Just to give you a quick example of that dial that I’m talking about — in early 2016, during the market selloff, high-yield and bank loans I think accounted for 45% to 50% of their portfolio, when there was a lot of attractive opportunity. Whereas today, that exposure I think was in the mid-single digits. There are dramatic swings in what types of credit exposures you can see.
What we expect overall from Guggenheim is that this strategy will produce attractive returns with low correlation to the traditional fixed-income market — making it really an excellent complement within a multi-manager framework.
PS: Perfect. Thanks, Jack.
When you were introducing Guggenheim, you mentioned some segments outside of the Agg. Can you briefly touch on that?
JC: Sure. The slide that’s up right now is very similar to what you were looking at with the BBH opportunity set. You’ll see different types of securities — including CLOs and legacy non-agency MBS and even some ABS within the aircraft space.
There’s that triangle — diamond — the Bloomberg Agg. You can just see the much more attractive similar-if-not-better yields, with a lot less duration.
PS: Perfect. Thank you very much, Jack. Really appreciate it.
Jason. We’ll switch to you, now. Would you mind giving us an overview of the remaining two strategies on the fund?
JS: Sure. Thanks.
I’ll start with the Neuberger-Berman. Derek Devens and his team are writing out-of-the-money put options on US stock indexes. The S&P and Russell 2000. Investing the collateral in a portfolio of short-duration US treasuries.
This is generating income from both the receipt of the premiums on the put-options as well as interest earned on the collateral portfolio. This is conceptually a pretty straightforward strategy. It’s not dependent on leverage or on timing the market or complicated multi-pronged trade-structuring for success.
It’s really about taking advantage of the insurance premium. You get paid to assume that downside risk of the equity market. Being smart about diversifying the parameters of the option book — like the expiration dates, the strike-prices, et cetera, et cetera.
They’re doing that to reduce the path-dependency that you’d otherwise get if you just write one option a month. Or at the extreme, one option a year — if you think about going out to the most ridiculous thing you can think of.
As I said, that’s going to diversify the risks, smooth the ride and really reduce the path-dependency so that you capture as much of that premium as you can without taking undo risk.
We think this is a really good strategy, complementing the core credit strategies. We like it a lot as part of a diversified income fund. We really like the fact that it systematically is taking advantage of the market’s tendency to overpay for downside protection.
It’s a really high risk-adjusted return strategy. In addition to that, we think the team does a great job actively managing risk and thinking about capital efficiency.
Now we know that Neuberger-Berman also manages a put-write mutual fund strategy. Can you just talk about how the strategy they’re managing for us is different than that?
It’s conceptually very similar in terms of the overall philosophy. Mostly in terms of execution. The key difference here is that it’s the selection of the strike-prices of the options.
Neuberger’s own fund writes at-the-money put options. If you’re thinking about it in terms of insurance, they’re exposed to the full loss of the index. Meaning they have no deductible on the policies they’re writing.
In our fund, they’re writing puts that are about 2% out-of-the-money on average. That gives you significant cushion against the average monthly loss for equity markets.
Obviously, by taking somewhat more risk, the Neuberger-Berman fund expects to generate higher returns over time. But with more volatility and larger drawdowns.
The implementation that they use should produce equity-like returns over the long-run, with call it roughly 2/3 of the volatility of equity markets. The strategy that they’re managing in our fund is more akin to high-yield type returns — again, with significantly lower volatility than owning high-yield.
We can also have some flexibility in the collateral management in our strategy. We don’t expect that to be a big piece of it, going forward. But there is that possibility if we’re in a very different interest rate environment, that we could exercise that.
PS: Okay. Perfect. Thank you.
JS: I guess I’ll turn to Ares, now.
This is a team that’s investing in specialty, income-generating public securities. Primarily business-development companies, mortgage real estate investment trusts. Master limited partnerships. And the related infrastructure C-Corps. Because there are a lot of conversions happening now.
Then selectively in credit-based closed-end funds that are trading at discounts to their net asset value.
We really like this combination because the PMs here come from the sell-side where they covered these sectors for a long time — 10 to 20 years. We like having them managing this niche strategy within Ares, which — as people probably know — is a very large global multi-strategy alternative investment management firm.
Ares manages the largest BDC in the industry. They manage a commercial mortgage REIT. They have a ton of private energy investments. They have a really large business investing in public high-yield bonds, leveraged loans, and they’re one of the largest private credit managers in the country — with significant private direct-lending business. In addition to their publicly-traded BDC.
Ares has a ton of expertise in all of these areas. We think the PMs should really be able to benefit from the power of the overall platform, as Ares stresses sharing knowledge and really trying to leverage all of the possible areas for the benefit of each other across their different investment businesses.
That in addition to the PMs’ own deep knowledge and expertise, we think should be really powerful.
Looking at this slide here, we can see over time, the expected asset-allocation is roughly 60% to BDCs, 20% to mortgage REITs and 20% to MLPs, with opportunistic allocations to closed-end funds and other potential income opportunities that may come up.
Important to note here — although this is the long-term expected average, the PMs have quite a bit of flexibility to deviate from that and to move capital to where they’re seeing the best risk-adjusted opportunities.
If you flip to the next page, you can see the yields here. The four over on the right are the yields on the target asset classes that this strategy will be investing in.
If you look at those numbers, you obviously have a big tailwind in those areas, relative to traditional fixed-income allocations. That’s just at the asset class level.
So even if you assume no alpha on top of that, you’re looking at really nice income-generation. There’s obviously some volatility associated with that since these are publicly-traded, and they can move around. But assuming you think over time it’ll be roughly akin to the returns you’re starting with, it’s really nice income-generation.
We obviously think that the PMs are going to add value on top of those returns through both capital-allocation — moving capital back-and-forth between these sectors opportunistically, as well as securities-selection at the individual company level.
So we’re really excited about the strategy and partnering with Ares.
PS: Perfect. Thank you guys so much for all the great detail on the subadvisors and the strategies.
As we look at the fund, after hearing all the detail on the underlying subadvisors, what are the current manager allocations for the fund? And how did you decide on them? Jack — did you want to take this one?
Jack: Sure. Manager-allocations were the result of combining a few quantitative and qualitative inputs. Qualitatively, it started off with our understanding of each of the managers themselves. Then their investment strategies.
Then we considered some forward-looking expectations of their individual risk-profiles as well as the likely returns that we’d expect to see across a range of economic and interest-rate scenarios.
To support our initial qualitative thinking, we looked at some historical performance, which consisted of actual track-records, as well as some asset class performance data. Just to give you some context there — in the case of Guggenheim — they run a separate-account strategy that has a performance-record going back around 10 years.
BBH has a track record that covers some of that history. Ares and Neuberger have shorter track records.
But ultimately, what we were able to put together was a common [inaudible] actual and what we felt were really good representations of all four managers’ strategies. We got really comfortable with that.
Looking at those hypothetical results, I’d point out that that information was pretty consistent with our initial forward-looking expectations. We were able to just gain a lot of confidence in the allocations that we came up with.
From there, we ran different combinations of allocations to the four managers. Those results, again, were consistent with our ex-ante range of allocations that we initially drew up.
Going in, we thought we’d be overweight to BBH and Guggenheim, as they have the most flexible strategies with the widest opportunity sets. We have much longer histories of investing with both of those firms.
One of the obvious questions, as you look at this chart, is maybe, “Why is Ares the lowest-weighted, and Neuberger also a lower weighting,” than the other two. Just Ares, for example — that’s a strategy that I’d say first-off, we had a lot of confidence in. But it does have the largest downside and the most volatility of these four strategies.
As Jason touched on, it does invest in these publicly-traded nichey equity securities, such as BDCs and MLPs. That can have some stock-like downside risk.
That said, we also expect Ares to have the highest long-term returns of the four managers. So the lower allocation was mostly — definitely — a risk-management piece of our decision. We didn’t want to over-expose the fund to meaningful short-term downside.
I’d say also there was a qualitative input, as they were the managers that we probably had the shortest background with. But very importantly, we were obviously very impressed with them, or we wouldn’t have put them on the fund.
Then Neuberger — which is also a lower weight than BBH and Guggenheim — that, too, can have some short-term downside. We have a lot of confidence in this strategy, but factored the risk-reward characteristics into their allocation. So overall, it’s just a mix of qualitative and quantitative inputs, as ultimately we were able to achieve the desired risk/return portfolio characteristics that we were looking for.
PS: Okay. Thank you very much, Jack. Appreciate it.
Just a quick reminder to everyone on the call today. If you would like to submit a question, please do so using the Go-To Webinar desktop-control panel, and type in your question.
We’ll begin addressing live questions in a few moments. However, if we’re unable to address your question on the webinar due to time constraints, we will follow up with you individually.
Jeremy — I’m going to come back to you, now.
If you could just please talk a little bit about the role or the roles that the High Income Alternatives Fund can play in a portfolio?
JD: Sure. I think these are relatively straightforward and brief. But I guess there are probably two ways to think about the fund in a portfolio. Then I’ll tell you how we’re thinking about it.
The fund can be used as part of an investor’s diversified fixed-income allocation. Or potentially as part of an alternative strategies allocation.
In the Litman Gregory client portfolios, we use the fund or will be using the fund as a long-term strategic allocation. Part of our diversified fixed-income exposure that complements our more traditional core bond investments and other income-oriented investments.
As we are going to be funding the position, the new fund will be coming from parts of our existing flexible income and floating-rate loan investments. We view this as part of a diversified fixed-income non-core allocation, but others may consider it more in the alternative-strategies bucket. I guess there may be other ways to think about it, but that would be our response to that.
We have one more slide on there?
Yes. I guess the last two slides here — the heading there is, “The Case for High Income Alternatives.” These are probably points that most everyone on the call is well aware of. But we have a strategic role for the fund — a strategic rationale, as I’ve mentioned. We view that as a long-term allocation.
Certainly in the current environment, we think there’s a strong case to be made; particularly in the timing of it. In that we have an environment of very low yields — and coinciding with that, high interest-rate risks. So relatively low yields and relatively high-duration. When you’re talking about core bonds and even moving into credit areas, we know that spreads are very tight.
That’s been the case for a while.
To the extent that interest rates are rising, that’s another headwind to having this core bond exposure. Those are more tactical reasons that have certainly played into why we’ve had meaningful non-core fixed-income exposure in the client portfolios we manage.
That’s the Litman Gregory Investment Advisory part of our business. Where we have exposure to these flexible fixed-income funds and where we’ll be allocating to the Masters High Income Alternatives Fund.
We think — hopefully — we’ve highlighted on today’s call that there are still some good opportunities to generate higher income and returns without ignoring risks or stretching for yield. And to add portfolio diversification from managers that are able to invest in and have expertise in these less-traditional and less-efficient areas of the market.
PS: Perfect, Jeremy. Thank you.
We’ve had a couple of questions come in through the webinar this afternoon. Jeremy, can you take the first one?
Can you please comment on how the High Income Alternatives Fund compares to the Alternative Strategies Fund? Then can you please also differentiate possible portfolio usage for the High Income Fund vis-à-vis the Alternative Strategies Fund?
By the “Alternative Strategies Fund,” I’m assuming their question is about the Litman Gregory Masters Alternative Strategies Fund. That probably goes without saying.
I guess —
How is High Income Alternatives different than that? I think they have different strategies; different managers; different investment approaches and objectives. Different investment universes and opportunity sets. And different ultimate drivers of risk/return.
Those are a lot of differences.
Maybe stated differently, the Masters Alternative Strategies is more absolute-and-total-return oriented. Talking about the opportunity sets and risk/return objectives, several of the strategies on the Masters Alternative Strategies Fund have long/short exposures and may hold significant cash positions.
Again, really hedging risks or meaningfully reducing risks in order to have a focus more of a total-return or an absolute-return orientation.
The strategies on the Alternative Strategies Fund are also very diverse and highly differentiated from each other. Ultimately with Alternative Strategies, they’re intended to generate returns that are not highly dependent on or driven by the direction of traditional bond and stock markets.
High Income Alternatives Fund obviously focuses on income strategies. Income is likely to be the primary source of return over time. While these strategies are also highly differentiated and flexible as we’ve talked about, also the sources of income are going to be coming from these non-traditional market segments. We do expect the high-income fund overall will be more subject to broad credit market headwinds and tailwinds.
In terms of how we think about both funds within our Litman Gregory client portfolio-construction, as I’ve just mentioned, we categorized the Masters Alternative Strategies Fund within our Liquid Alternatives Strategies bucket. We would categorize Masters High Income Alternatives as part of our diversified non-core fixed-income bucket.
I guess I’ll leave it at that.
PS: Perfect. Thank you.
Thank you for all of the detail; appreciate it.
We had another question come in, Jack. This one will be for you.
Can you just talk about some of the differences between the BBH and Guggenheim strategies that they’re managing for the fund?
Jack: Yes. Absolutely. That’s a good question.
They both are actually obviously in the credit spectrum. I’d say to differentiate them, I think Guggenheim does utilize a somewhat wider opportunity set. Although BBH does have ample flexibility to invest across fixed-income sectors and credit-qualities.
I guess I’d point out that while they can maybe often fish in some similar ponds — let’s just take asset-backed securities as an example — they have differentiated approaches and criteria that they utilize.
One example that comes to mind is that I think on the margin, BBH invests in more mature and proven industries, while Guggenheim has more of a willingness to invest in newer industries. I guess solar energy might be an example of that type of difference. BBH is just more conservative and wants to have some valuation framework to draw from when they do the stress-testing of their securities.
I’d also say that while both portfolios are driven by bottom-up credit opportunities, Guggenheim does have more of a top-down component or overlay to what they do. Guggenheim is far from a market-timer. But their portfolio-positioning will be influenced by intermediate-term market views. Definitely more so than BBH.
I think BBH I’d expect to also be a little bit more concentrated. As I pointed out earlier, they might have somewhere in the ballpark of 85-or-so issues within their securities. And even fewer issuers.
I would point out that when we considered these two managers in the credit space, we were actually pretty excited and felt that they were very complementary to each other. We compared and contrasted some portfolios and were able to view the two firms. There was very little overlap among the issuers. In the case where there was a similar issuer, what we often saw was that they were different within the issuer’s capital structure.
So we feel very excited to have these two credit managers that we have a lot of conviction in. They can provide the fund with diversified exposure across the credit markets.
PS: Perfect. Thank you so much, Jack. Appreciate it.
Let’s see here. We had another question come in. Jason — we’ll ask you this one.
Are any of the managers in the fund looking to actively hedge or lessen their equity and interest rate risk?
JS: Well, there’s not much direct equity risk in the fund. Areas that Ares invests in are obviously publicly-traded, so they do have some beta to the equity market.
But they’re not actively looking to hedge that out. It’s really much more about portfolio-construction and how we sized it within the fund, as Jack talked about — keeping it to slightly smaller allocations because of that potential for volatility.
Hedging tends to cost money over time. A big component of this fund — what we’re trying to achieve — is high income. So we think that sizing things appropriately is kind of the way to handle that generally.
There’s the potential to hedge interest rate risk. But generally, and Jack may want to speak to this in more detail — but —
Generally, the managers will be handling that by their securities selection. A lot of their portfolios will be floating-rate rather than fixed-rate in this environment. I don’t have the exact numbers in front of me, but the majority of the portfolios will be floating-rate, currently. That’s kind of the interest rate risk.
JC: The one small piece I’d add to what Jason just said is that BBH or Guggenheim — to Jason’s point — obviously, most of that interest rate risk is derived from credit selection in and of itself.
They both can use some US Treasury futures and manage duration. That really just allows securities selection to be managed independently from the portfolio duration.
I’d stress that BBH, for example — anytime they are using a treasury futures, for example — this is more in a defensive posture, as opposed to if we lever up to increase our returns.
So it’s more —
Maybe that’s a little insight into their risk-consciousness and how they manage portfolios.
PS: Okay. Excellent. Thank you guys.
We have time for a couple more questions. Jeremy?
PS: I’ll ask this one of you.
The advisor asks, “Why is the benchmark Aggregate Bond when so many asset classes used are outside of the benchmark? Why not use the universal index?”
JD: Yes. We had many benchmark discussions among the team, and talking to the subadvisors.
There’s no single one best benchmark for this fund. It’s diverse strategies across different investment — financial — markets. Even outside of fixed-income.
Universal was one that we considered.
Ultimately, there’d be plenty of reasons why the universal index is also not representative of the full opportunity of the set of the fund. It’s still a relatively obscure index.
We basically defaulted back. I shouldn’t use the word, “Default,” when you’re talking about it. Going back to the Agg-bond index — as you know, it’s the “industry standard” for the bond market.
Importantly, we bookend this with a secondary benchmark, which is the high-yield index. Again, this is not a high-yield junk-bond fund, but we think that that’s a relevant benchmark to also compare the fund to, as we’ve discussed.
We’re not claiming the Agg is perfect, by any means. But it’s kind of the industry standard. And it is a relevant benchmark when we’re talking about this fund as a replacement and a diversifier for traditional core fixed-income.
PS: Perfect. Thank you, Jeremy. Appreciate it.
Jack, we had another question come in. This one, if you could address this question —
The advisor asks, “Guggenheim has had some organizational challenges recently. Why allocate so much to them?”
JC: Yes. That’s a good and timely question, I’d say. With any bit of negative press that’s come out on Guggenheim, we’ve been on top of it. We have scrutinized them and have been on the phone very frequently with them, to make sure that we weren’t missing anything.
This not only impacts our investments in their mutual funds for our private-client business, but also in consideration of Guggenheim for this fun.
What I can tell you is that we’ve had extensive conversations with numerous people. Not only from their senior investment professionals, but also in terms of their global heads of legal and compliance. We know their chief operating officer.
As part of this, I’d say that one useful person to have on our side as we went through these questions with Guggenheim was our own mutual fund chief compliance officer and chief operating officer, who has a much better handle on any of these issues that are being brought up in the press.
One thing I can tell you is that ultimately, after all of these issues, we came away still comfortable with using Guggenheim in our fund. That just reflects our high confidence in them. Not only as investors, but in how they take their fiduciary responsibility seriously.
There is — and I know this is going to sound nuancy — but —
There are different sides of this business. Most of the issues that have been raised within the press are dealing with more of the other private or institutional side of the business. Not with the Guggenheim investment teams that we’re dealing with on a daily basis.
We’ve had numerous calls. We’ve reached out to authors of newspaper articles that had negative things to say. We’ve asked recruiters if they’re seeing any negative departures from Guggenheim seeking other jobs.
If anything, I can tell you that we have had several conversations with numerous senior personnel at Guggenheim. Just to reiterate what I said, we think they’re all very serious in how they take and share responsibility. We felt very comfortable with what’s being said in the press.
PS: Perfect. Thank you so much, Jack. Really appreciate it.
We have time for one more question, it looks like. Jason, we’ll ask this one of you.
The advisor asks, “There’ve been a number of private credit-related funds that have been established recently as interval funds. Any consideration given to interval, given the illiquid nature of securities?”
JS: Yes. We did actually talk about it. I don’t think we got extremely close to using an interval-fund structure for a number of reasons. One of the primary ones being that most of what we’re doing in this fund is very, very liquid.
We’re certainly not naïve. We know in stressed markets, some areas of credit can get less liquid. The smaller issue-sizes — the more complicated structured-credit areas, particularly the higher-risk tranches in those securitizations — can get less liquid.
We’re not blind to the fact that that can potentially become an issue. But we’ve got very diversified portfolios from the credit managers, and then significant pieces of the portfolio that are not directly invested in credit securities.
We don’t think it’s something that we needed for this portfolio. We’re very interested in how these interval funds are going to do, both from a business perspective, as well as actual investment returns. It’s something we’re watching closely and continuing to track into the future. I’ll say that.
PS: Perfect. Thank you very much, Jason. Appreciate it.
Okay. I think that’s all the time that we have for today.
We want to thank you all again for joining today’s webinar and for the continued confidence in Litman Gregory.
As a reminder, a replay of today’s call will be posted to the Masters Funds website at www.MastersFunds.com. In the meantime, if you have any questions, please contact the Masters Funds sales team, whose contact information can be found here, and also on the Masters website.
Thank you very much and have a great week.