Interviewee: Jason Steuerwalt
Interviewer: Mike Pacitto
Date: August 18, 2023
Mike Pacitto:
Hi everyone, I’m Mike Pacitto with iM Global Partner. Thanks for joining us for this 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.
With the Alternative Strategies fund we believe have designed a compelling multi-manager, multi-strategy solution for allocators and investors to incorporate core alternatives – in a single holding – that delivers meaningful diversification, and a simultaneous ballast, for traditional stock and bond portfolios.
As clients already know, earlier this year we upped our allocation to the DoubleLine Opportunistic Income strategy – this tactical overweight is because of how attractive we believe this sleeve of the portfolio is currently priced, which Jason will get into later. Otherwise, the underlying distinctive orientation – a diverse grouping of separate account strategies unique to this fund – remains intact.
In terms of performance of the fund, you’ll see here that the fund has meaningfully outperformed t-bills and the Agg Bond index as well as the Morningstar peer group since inception. In fact, the fund has consistently remained in the top quintile of its peer group in terms of Sharpe Ratio since it launched in 2011.
More recently, while the fund was down in 2022, it was down much less than equities and core bonds. The fund is positive for 2023 through July a bit over 3%, which is better than the Agg Bond index by 100 basis points. Along those lines, while many clients use the fund as a core alternative fund, many other clients use it more specifically as a diversifier for their bond portfolio. In this respect, the Alternative Strategies fund has really shined – it beat the Agg Bond index in 2022 by over 400 basis points, and historically since inception annualized has beaten the Agg Bond index by 295 basis points, while maintaining a similar standard deviation volatility level and yield, with very low correlation, thus providing real diversification benefits to bond allocations.
In fact, the fund’s downside average return has been less than a quarter of the Agg during down periods, and 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, let’s get more in-depth here on the underlying managers and strategies.
Jason Steuerwalt:
The Blackstone Credit (fka as DCI) strategy was a good contributor even amidst the continued market cross currents and gyrations, gaining 4.5% net in the first half of the year. The strategy has continued its run of good performance from last year. (It’s up almost 11% net over the trailing year with very low beta to HY.)
As a reminder, this is a systematically implemented strategy based on DCI’s model of fair value corporate credit spreads, consisting of a long-short market neutral CDS portfolio and a HY cash bond sleeve where HY beta and interest rate duration are hedged to low levels. As we note here, security selection gains in the portfolio were broad‐based and both the CDS and cash bond sleeves contributed to performance in Q2 and YTD.
The portfolio was well hedged over the period in terms of credit beta and rates, so the macro impact was very limited and credit selection drove performance, which is what we’re looking for. An increased market focus on fundamental performance is good for the strategy, and with credit differentiation a market theme, the portfolio’s underweight to high‐default‐probability names and tilt into stronger credit quality has worked really well.
This sleeve of the fund is one of the least correlated to traditional assets and other managers, and has historically protected capital very well during market stress periods, so it’s really good to see it also having a strong year during a general recovery as well.
Pg 7 – DoubleLine
As Mike mentioned, we made DoubleLine’s sleeve a tactical overweight at the beginning of this year, and we’ve highlighted the very attractive high level portfolio characteristics here, namely the yield of about 10.5% and low average dollar price, creating what we think is a compelling asymmetric return profile. It’s up a few percent YTD but we expect even better performance over a multi-quarter timeframe.
The portfolio retains its classic barbell of duration and credit, but it’s significantly more attractive than it has been in years, given that yields for the safer, longer duration assets, namely Treasuries and Agency MBS, are much higher than they were for most of the last decade, without the typical negative convexity of Agency MBS. So you get the benefit of a hedge against economic weakness and potential gains from a flight to safety while still producing high levels of income, rather than having a lot of potential downside if rates increase. This balances out the credit exposures across the rest of the book, namely non-Agency RMBS, which is still the largest allocation in the portfolio, CMBS, ABS, CLOs, etc.
The top-performing sectors in the portfolio during this period were all out-of-index assets. Specifically: domestic High Yield bonds (a small allocation), CLOs, Emerging Market debt, and residential credit exposures. All of these sectors generated strong interest income and benefitted from credit spread tightening. The CLO allocation naturally benefitted from its floating rate coupons and tremendous levels of carry. Emerging market debt and US residential credit were additional examples of assets that saw underlying credit fundamentals outperform base case expectations from the start of the year.
We’re obviously very positive on the outlook for this portfolio, hence the significant overweight. The last time we saw yields on this sleeve approaching these levels, the subsequent annualized returns over the next two years were well into the teens.
Pg 8 – DBi
As a reminder, this is a strategy we custom designed with DBi, consisting of a 75% allocation to trend following and 25% to Equity Hedge replication with some additional risk control tweaks. The timing of the addition last year proved unfortunate, but the EH allocation was beneficial. It was gratifying to see DBi’s portfolio rebound strongly from the Q1 losses that were largely driven by the regional bank failures. Despite the challenges since we added it, this is a powerful diversifying strategy should make the fund more resilient to different market conditions over time without sacrificing overall absolute performance.
The Enhanced Trend portfolio gained 6% during the second quarter after falling by almost the same amount in the first quarter, leading to a net loss of approximately 0.5% for the first half of the year. The sudden banking crisis in March caused significant uncertainty which led investors into safe haven investments, especially treasuries. Due to this, the short interest rate positions, as well as a short in the Japanese Yen versus the U.S. Dollar, detracted from performance in Q1.
The Euro was also impacted by the Credit Suisse failure which led to a volatile first quarter. However, a well-timed increase in exposure towards the end of February led to gains for the quarter. Commodity swings whipsawed positioning in crude oil and gold due to market participants torn between a hard or soft landing from the rate hikes. Equity asset classes were highly correlated during Q1, and a large rally in January due to hints about the end of the hiking cycle was reversed in February then as contagion fears abated, the rally resumed in March. The volatility caused swings in positioning which further contributed to losses.
In Q2 the Japanese Yen declined significantly as a result of widening policy spreads; central banks globally continued to tighten while the Bank of Japan maintained its yield-curve control. An elevated short position in JPY contributed to performance. A significant short position in 2-year Treasuries further benefitted performance. Developed markets, ex U.S., declined sharply during May, hurting the portfolio’s quarterly performance, but were positive in April and June, somewhat muting May’s impact. A reversal in gold markets also detracted from performance.
At the end of Q2, the portfolio was still short Rates/Bonds, short JPY, neutral to Commodities, and somewhat net long Equities, mostly coming from the US markets.
Pg 9 – FPA
The Contrarian Opportunity portfolio rose over 6% during the quarter. Mega-cap internet/technology names that got crushed in 2022 drove performance.
Activity was relatively light during the quarter. There were a handful of new positions added, including a financial software company and a fixed income position in a financial services company that suffered a downgrade.
The portfolio largely retains its general “barbell” of:
high-quality dominant franchise positions at reasonable valuations, largely in the tech and communications spaces, andcheaper but somewhat more cyclical value stocks like financials and industrials.
Additionally, there are a handful of special situations and a healthy cash balance of 26%
Equity exposure is 64% with approximately one-third of that in non-US positions.
Credit exposure continues to methodically increase, ending the quarter at 6.5%. FPA has historically added significantly to credit exposure during periods of market stress and is waiting for the opportunity to do so again.
Pg 10 – Loomis
Although not as high yielding as DoubleLine, the Loomis Sayles portfolio is also very attractive, yielding almost 8% with a duration of a little over 2. Hence, we didn’t fund any of the overweight to DoubleLine from this portfolio. Loomis has a larger allocation to corporates, and significantly less to mortgages, resulting in a lower duration and lower yield.
The Fund’s positive absolute performance was diversified across many sectors, with the majority generated from investment grade corporate bonds, securitized assets, high yield corporate bonds, and dividend equities. Emerging markets detracted from performance during the period, driven by some remaining exposures in China.
The portfolio’s largest net allocations continue to be to securitized, at almost 28%, with HY (22%) and IG (21%) following. Additionally, complementary positions in equities, convertible bonds, and emerging market credit positions collectively account for almost 15%.
Pg 11 – Water Island
In this environment, the landscape for event-driven investing has faced heightened volatility. The merger arbitrage strategy in particular has encountered significant regulatory challenges. Antitrust regulators around the globe have attempted to block several large mergers and acquisitions (“M&A”) transactions, in turn driving correlated volatility in deal spreads throughout the investment universe. At times, the logic behind the regulators’ recent cases was perplexing – especially in the US, where the Department of Justice (“DOJ”) and the Federal Trade Commission (“FTC”), in WIC’s opinion, have sought to block deals using novel legal theories with little basis in historical precedent – or what appears to be a foundation in a political agenda rather than antitrust law.
With their attempts to block deals in court, the FTC and DOJ have succeeded in causing some companies to abandon their planned tie-ups rather than take the fight to trial. In addition, the regulators’ actions may also have had a chilling effect on M&A in certain sensitive industries or by large acquirers, as we will never know how many deals that companies may have wanted to pursue were never announced. At the same time, we are seeing signs that the regulatory pendulum may be starting to swing back to the other side.
At this point, of the cases that have gone to trial, the FTC and DOJ under the Biden administration have lost more than they have won. The most recent example is the FTC’s attempt to block Microsoft’s acquisition of Activision. At the end of June, based on the trial’s proceedings and the skeptical tone of the presiding judge’s questions to the FTC, WIC believed it likely Microsoft would prevail. (Indeed, in July, the courts have not only officially ruled against the FTC but also rejected its attempted appeal.) These successes on the part of dealmakers may cause acquirers to increasingly take a bolder stance in fighting regulatory objections.
Looking ahead, while cognizant of the challenges that remain, WIC believes the return opportunities in merger arbitrage are compelling. Volatility and rising interest rates are bolstering wider deal spreads, which reached average levels not seen since the Global Financial Crisis. According to Dealogic data, the average day-one gross spread (i.e., the non-annualized spread the day after deal announcement) of pending deals as of June 30, 2023, was 9% – nearly double the rate on January 1, 2022, just 18 months prior.
Additionally, although M&A deal flow has slowed from recent peaks, the level of activity continues to provide plentiful investment opportunities. Current deal flow still exceeds pre-pandemic 2019 levels, and WIC anticipates a pick-up in consolidation activity should the Fed succeed in tamping down inflation and interest rates begin to stabilize. In such a scenario, they expect business leaders will increasingly seek to drive growth through strategic M&A, while private equity firms – still sitting on approximately $2.5 trillion in dry powder – will seek to put capital to work rather than return it.
Beyond merger arbitrage, given ongoing volatility in the broader markets, WIC continues to remain focused on hard catalyst investments, which should benefit from more definitive timelines and outcomes. In that vein, they are seeing attractive opportunities in merger-related credit and certain hard catalyst credit special situations, such as refinancings, and they anticipate the portfolio’s allocation to credit may grow in the coming months. They may introduce select soft catalyst investments – which typically have greater sensitivity to broader market moves – but only when they believe the potential reward outweighs the downside and when they can construct appropriate hedges.
Pg 12 – Risk/Return Stats
I don’t need to go into details here, as people can see all the numbers for themselves, but I guess I’d just say that I think we’re very close to a low point in terms of relative performance compared to the category, and frankly in absolute terms. Despite the disappointing performance last year, the fund is still doing far better than the Agg in absolute terms since inception and even during the poor run of performance for the fund and the Agg since the end of 2021. And we’re really optimistic about the fund’s potential from here.
The blended portfolio of DoubleLine and Loomis Sayles has a nearly 10% yield to maturity and duration of under five years. We don’t know when it will happen, but when Fed rate cuts begin to feel more imminent and investors start to exit the money market funds and short-term Treasuries that have become so popular, these spread sectors with high yields (some with a bit of duration) certainly seem likely to be beneficiaries.
Similarly, Water Island’s portfolio, although it has taken a few lumps due to regulatory challenges this year, offers a very compelling annualized gross deal spread of greater than 30%. As usual, we add the caveat that some deals do extend or even break, but with spreads at the highest levels seen since the GFC, prospective returns appear attractive. Higher rates and the unfriendly regulatory climate have set the stage for what could be a lucrative period for the strategy, especially considering the relative lack of success the Federal Trade Commission (FTC) and Department of Justice (DOJ) have had in their merger challenges..
Ultimately, we have a big part of the fund’s portfolio where discussion of the attractiveness of their opportunity sets can reasonably include ‘not since the GFC’ references. We are reasonably confident that we don’t face a similar risk of systemic financial collapse as we did back in 2008, so we believe this is a pretty strong indicator of the potential for (very) attractive returns going forward. And these are the harder catalyst parts of the portfolio that make up almost 60% collectively and haven’t even performed that well yet. So again, we’re really excited about the fund’s positioning and we look forward to hopefully reaping the rewards over the coming quarters.
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: team@imgpfunds.com
Thanks for spending time with us today.