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Article Update on iMGP ETFs & Mutual Funds

The beginning of 2022 has seen a quite rare situation in which almost all equities and fixed-income indices have been in negative territory. It started with a growing recognition by both markets and central banks that the very easy monetary policy put in place in 2020 has become inappropriate with inflation running at 40-year high and solid numbers for economic growth. Beyond the expectation for rising short-term rates, with the Federal Reserve’s tightening playing the main role, investors now also must consider huge geopolitical instability following the large-scale invasion of Ukraine by Russia launched on February 24.

Many Western governments responded with heavy sanctions on Russia. The impact of those sanctions will mainly fall on the Russian economy. Based on IMF data, Russia is the 11th largest economy but is sub-2% of total global GDP. For comparison, the two largest economies—the United States and China—comprise 24% and 18% of global GDP, respectively. 

The global economy—and Europe in particular—could be impacted by higher energy costs given Russia is one the world’s largest exporters of oil and gas. Crude oil prices have jumped nearly $20 a barrel well over $100/barrel since the conflict started, and that is on top of oil’s 50% price surge in 2021.

The Ukrainian crisis has created a particularly unclear situation for central banks as well as market participants. Higher energy and food prices will further increase inflation just at the time that bringing it back under control had become the top priority agenda for the Fed, but the growing turbulence in the world economy may pave the way for a much softer tightening in order to find the right balance.

In that context, fixed-income markets have been particularly volatile. Core bonds—which investors have historically counted on as ballast to protect their portfolios—have fallen 3.1% year to date in the U.S. as of March 4 while EMU (European Monetary Union) equivalents are down 1.7%. Bonds have not acted as they typically do in risk-off markets due to the cocktail of rising interest rates, high inflation, and upcoming rate hikes from the Fed and have been particularly choppy during this stretch.

Equity markets have continued their slide that began in January. In February, the S&P 500 was down as much as 12% from its all-time high earlier this year. Value stocks outpaced growth stocks—the latter continues to face the headwind of higher interest rates and subsequent impact on their loftier? valuations. Year to date, the Russell 1000 Value Index is down 3.5% compared to a 14.5% drop for the Russell 1000 Growth Index. But, since February 23 (last close before Ukraine invasion), both indices have posted similar positive returns slightly above 2%.

The main rotation in equity markets since the war started has indeed been the spectacular geographical rotation penalizing European markets and favoring US as illustrated by the chart below.




Source: iMGP & Bloomberg. Data from December 31st, 2021 to March 4th, 2022. Past performance is not a reliable indicator of future results to March 4th, 2022. Past performance is not a reliable indicator of future results.

US ETF & Mutual Fund Strategies

iMGP Dolan McEniry Corporate Bond Fund [IDMIX, IDMAX]

Year to date, U.S. Treasury rates went up, and the curve flattened as long-term rates rose less than short-term rates. Additionally, both investment-grade and high-yield corporate bond spreads widened. This combination of higher rates and wider credit spreads led to negative returns in most fixed-income products. The Federal Reserve has become less accommodative: the tapering of asset purchases ended in March and a new Fed Funds rates hikes cycle is set to begin. Uncertainties in monetary policy and geopolitical events have caused spreads to widen and interest rates to rise over the last several months. However, financial conditions are strong, and Dolan McEniry will continue to monitor markets for opportunities to add value to client accounts.

The 10-year U.S. Treasury yield increased from 1.51% to 1.83%, and the 2-year yield increased from 0.74% to 1.44%.  U.S. Treasuries rates have risen from all-time lows; however, they are still low on a historic basis. Per Bloomberg data, spreads on corporate investment-grade bonds widened 30 basis points to an average option adjusted spread (“OAS”) of +122 basis points. The OAS of the Bloomberg Corporate High Yield Index widened 76 basis points to +359 basis points at February end.

In this environment, iMGP Dolan McEniry Corporate Bond, managed as the main strategy of Dolan McEniry, protected the capital of clients more than corporates in which the fund is invested and protected more than the Bloomberg US Corp Bond TR USD, as shown below.

Below is the performance of the iMGP Dolan McEniry Corporate Bond to 03/04/2022 in USD:

Source: iMGP & Morningstar. Data from December 31st, 2021 to March 4th, 2022 in USD. Past performance is not a reliable indicator of future results.

Dolan McEniry believes that the fund is positioned to provide potential absolute and relative returns going forward. Dolan McEniry’s core competence is credit analysis, and they focus on a company’s ability to generate generous amounts of free cash flow over time in relation to its indebtedness.

Dynamic Beta investments Managed Futures Strategy [DBMF] and Hedge Strategy [DBEH]

The Managed Futures and Equity Hedge strategies managed by Dynamic Beta Investments have performed better than equity and fixed-income markets year to date in USD.

In particular, iMGP DBi Managed Futures strategy ETF benefited from its exposure to commodities, essentially to crude oil and modestly to gold liquid futures. It also benefited from its currency exposure and modestly suffered from its long rates and equities futures exposure.

Below is the performance of the iMGP mutual funds sub advised to Dynamic Beta Investments to 04/03/2022 in USD:

Source: iMGP & Morningstar. Data from December 31st, 2021 to March 4th, 2022 in USD. Past performance is not a reliable indicator of future results.

iMGP US multi-manager funds [MASFX, MAHIX]

iMGP Alternative Strategies (MASFX) and iMGP High Income Alternatives (MAHIX) have provided some capital protection and limited volatility, in an environment where all traditional asset classes have posted significant negative returns.

In MASFX, limited long exposure to equities mainly due to the contrarian opportunity sleeve has helped to cushion the negative effect of the market correction while the event-driven arbitrage sleeve has also managed to show good resilience in this adverse environment.

In MAHIX, exposure to equities through index put options writing has slightly weighed on performance with the equity drop but may benefit in the coming weeks as the spike in implied volatility has driven premiums higher. For both MASFX and MAHIX, selective exposure to credit markets supported by an environment of strong corporate profitability and low default rates provided ballast for both strategies but could not provide positive absolute returns as volatility and outflows in most fixed-income markets have widened spreads.

Source: iMGP & Morningstar. Data from December 31st, 2021 to March 4th, 2022 in USD. Past performance is not a reliable indicator of future results.
Source: iMGP & Morningstar. Data from December 31st, 2021 to March 4th, 2022 in USD. Past performance is not a reliable indicator of future results.

iMGP Alternative Strategies Fund [MASFX] Portfolio Manager Commentary

We are writing to provide a brief update on the fund’s performance and positioning in light of the tragic situation in Ukraine and the resulting financial market reverberations. It should go without saying that we are horrified by the reports and images coming out of Ukraine. The human toll is incalculable, and our thoughts and sympathies are with all of those impacted. However, professionally we must carry on with our duties, including updating fellow fund shareholders about the fund’s status and outlook.

As of February 28, the fund had no exposure to Russian positions and less than 1bp exposure to a single Ukrainian position.

Many Western governments responded with heavy sanctions on the Russian economy. The impact of those sanctions will mainly fall on the Russian economy. Based on IMF data, Russia is the 11th largest economy but is sub-2% of total global GDP. For comparison, the two largest economies—the United States and China—comprise 24% and 18% of global GDP, respectively. The global economy—and Europe in particular—could be impacted by higher energy costs given Russia is one the world’s largest exporters of oil and gas. Crude oil prices have jumped dramatically to well over $100/barrel since the conflict started, on top of oil’s 50% price surge in 2021.

The Ukrainian crisis has created a particularly unclear situation for central banks as well as market participants. Higher energy and food prices will further increase inflation, just at the point when bringing it back under control had become the Fed’s top priority. However, the growing strain on the world economy may pave the way for a much softer tightening in order to find the right balance (to the extent one can be found).

In that context, fixed income markets have been particularly volatile. Core bonds—which investors have historically counted on as ballast in their portfolios—have fallen 4.0% year to date through March 8 (based on the performance of the Bloomberg U.S Aggregate Bond Index, “the AGG”). Bonds have not acted as they typically do in risk-off markets due to the cocktail of rising interest rates, high inflation, and upcoming rate hikes from the Fed and have been particularly choppy in recent days.

Not surprisingly, typical “risk-on” assets have fared even worse. High-yield bonds (measured by the S&P US High-Yield Corporate Bond Index) are down over 4% as high-yield spreads (ICE BofA U.S. High Yield Index Option-Adjusted Spread) have risen by almost one-third on the year, to just over 400bps. Equity markets have continued their fall that began in January, with a YTD loss for the S&P 500 of over 12%.

Growth stocks have struggled even more as they’ve faced the headwind of higher interest rates and lofty valuation multiples (the Nasdaq-100 Index is down over 18%). The main rotation in equity markets since the war started has been the spectacular geographical rotation penalizing European markets and favoring the U.S. European equities, which outperformed their U.S. counterparts in the first six weeks of 2022 have been hammered, and now trail the U.S.

Performance and Manager Commentary

The iMGP Alternative Strategies Fund is down 4.1% year to date through March 8, compared to the previously mentioned declines of 12.5% for the S&P 500, and 4.0% for the Bloomberg Barclays U.S. Aggregate Bond Index (Agg). Negative returns are never pleasant.

However, the fund is holding up much better than equity markets, as we would expect given its conservative mandate. The downside capture relative to equities is slightly more than we’ve typically seen historically, but not unreasonable or cause for concern in our view.

As we’ve emphasized in the past, the fund isn’t designed to be an explicit hedge for equity risk, although there have been periods where the fund has gained while stocks have declined. Rather, it is intended to provide some downside protection through managers’ portfolio construction and risk control and the inclusion of some uncorrelated (not necessarily negatively correlated) strategies. This permits our subadvisors to become more aggressive and increase exposure to favorable opportunity sets at more attractive valuations, yields, deal spreads, etc., planting the seeds for potentially strong performance. This pattern has been consistent over the fund’s life.

What is unusual so far this year is the fund’s return being similar to core bonds when they are struggling. The fund has historically been a strong diversifier to core bonds, displaying essentially zero correlation to the Agg while outperforming significantly over multi-quarter to multi-year time frames. This pattern held last year as usual, as the fund was up 2.4% during the first quarter while the Agg declined almost 3.4%, and the fund gained 3.8% for the year compared to a loss of 1.5% for the Agg. This year, however, the broadly felt “risk-off” sentiment, even for assets with strong fundamentals, has hurt relative performance at the same time that inflationary pressures and the expectation of significantly higher rates has crushed core bonds (traditionally a relative safe haven). So the respective drivers were different but the results were similar.

Loomis Sayles and FPA have struggled somewhat more than we might typically expect this year, with negative performance in the mid- and high-single-digits, respectively, on the year through March 8. This difference largely accounts for the negative delta between the fund’s expected performance based on historical experience (and fairly conservative positioning at year end), and actual performance this year.

The Loomis Sayles portfolio has been negatively impacted by high yield bond performance, although its exposure level was far from aggressive at the end of February. The combination of equity exposure (which was quite additive to performance over the trailing year) and emerging markets fixed income exposure has been the culprit behind somewhat disappointing performance. Both were toward the high end of typical ranges (high single-digits to low teens as a percentage of the portfolio) as of the end of February, indicative of where the Loomis Sayles team has been finding value. Both are areas that have contributed positively over time but have hurt this year (at the asset class level, not just in the Loomis portfolio).

FPA’s challenge has come from non-U.S. exposure, as nearly one-third of the sleeve’s risk exposure is non-US. Additionally, financials and large-cap tech names have been battered, both of which are significant holdings in FPA’s portfolio.

Moving on to the other three managers, DoubleLine’s portfolio is outperforming the Agg index for the year. Its allocation to structured credit (e.g., RMBS, CMBS, ABS) has hurt performance despite generally positive underlying fundamentals. These types of dislocations are generally short-lived as yield seekers come into the space to hunt for relative value in high quality assets, closing the gap. The longer-duration government-guaranteed portion of the DoubleLine portfolio has obviously been less helpful as a hedge this year than it has been historically since rates have risen.

Water Island and DCI are performing well within expectations, down slightly on the year, with DCI up in March.

Looking forward, we are quite optimistic about the fund’s performance potential.

To provide a bit of detail, as of the end of February, the Loomis Sayles portfolio had a yield of over 4% with a duration under 2.5. The DoubleLine portfolio sported a yield over 7% with a duration under 4.0. The cash bond sleeve of DCI’s portfolio yielded approximately 4% net of hedges with duration under 1.0, while DCI’s market-neutral CDS sleeve was running at the high end of its gross exposure range, implying a better opportunity set than we have seen the past year or two. Water Island’s portfolio of merger arbitrage deals has an above-average spread that translates to a high-single digit annualized return to expected deal close dates, and also benefits from merger arbitrage’s inherent hedge against rising short-term rates. Those strategies’ shorter durations all tend toward relatively quick rebounds from dislocations, while FPA’s style-balanced global portfolio of high-quality, attractively valued businesses should provide significant upside over a multi-year holding period. Returns could be “pulled forward” in a rapid revaluation, or take longer to play out, but shareholders have historically been rewarded for patience, as FPA has produced the highest returns in the fund. FPA also had significant dry powder (>20% cash) as of the end of February and were selectively adding to names they found compelling.

All of this is to say that while we are not pleased to be down in line with core bonds on the year, we think there is potential for our historic pattern of outperformance to resume. We obviously can make no guarantees regarding performance or timing, but we feel very good about the tailwinds the fund has in absolute terms and especially relative to core bonds. The AGG yields under 2.5% and has a duration over 6.5, which seems to us an unattractive combination.

As fellow shareholders, we greatly prefer our portfolio of flexible and risk-averse but opportunistic strategies run by managers who have successfully navigated through multiple market cycles.

Thank you for your confidence and we look forward to updating you again at quarter end.

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DISCLOSURE

iMGP Fundsʼ investment objectives, risks, charges, and expenses must be considered carefully before investing. The prospectus contains this and other important information about the investment company, and it may be viewed here or by calling 1-800-960-0188. Read it carefully before investing.

Effective July 31, 2020 the name of the Litman Gregory Masters Funds was changed to iMGP Funds.

Delta – Delta is the ratio that compares the change in the price of an asset, usually marketable securities, to the corresponding change in the price of its derivative.

Mutual fund investing involves risk. Principal loss is possible.

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

Each of the funds may invest in foreign securities. Investing in foreign securities exposes investors to economic, political, and market risks and fluctuations in foreign currencies. Each of the funds may invest in the securities of small companies. Smallcompany investing subjects investors to additional risks, including security price volatility and less liquidity than investing in larger companies.

The International Fund will invest in emerging markets. Investments in emerging market countries involve additional risks such as government dependence on a few industries or resources, government-imposed taxes on foreign investment or limits on the removal of capital from a country, unstable government, and volatile markets.

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 Alternative Strategies Fund may make short sales of securities, which involves the risk that losses may exceed the original amount invested.

Investment in absolute return strategies are not intended to outperform stocks and bonds during strong market rallies.

Merger arbitrage investments risk loss if a proposed reorganization in which the fund invests is renegotiated or terminated.

Leverage may cause the effect of an increase or decrease in the value of the portfolio securities to be magnified and the fund to be more volatile than if leverage was not used.

Multi-investment management styles may lead to higher transaction expenses compared to single investment management styles. Outcomes depend on the skill of the subadvisors and advisor and the allocation of assets amongst them.

Industry Terms and Definitions

The iMGP Funds are distributed by ALPS Distributors, Inc.