Deep in the MBS Skill Set
Semper MBS Total Return Fund
Author: Ticker Magazine
Last Update: May 29, 9:01 AM EDT
|Unlike other funds offering broad coverage, the Semper MBS Total Return Fund leverages its expertise in mortgage-backed securities. Greg Parsons, CEO and Chairman of the Investment Committee, believes that the MBS space is one of the best sources of risk-adjusted returns today when actively managed by a specialist. With a focus on capital preservation, the fund relies on a complex quant model and a set of principles refined over time.
“The mortgage credit market of about $500 billion is traditionally invested by large institutions, and it is our view that we can make a difference with our nimble and opportunistic style of portfolio management.”
Q: What factors guide the asset allocation decisions?
By design, we have to be 80% in mortgages, but we can go anywhere within the mortgage universe. So, we would analyze every sector of the market. Due to our internal diversification guidelines, we would never dramatically expose the fund to any particular sector. But one of the advantages of the space is that it is so fragmented and nuanced, that there is a lot of value to extract.
We have the tools to compare subsectors with different dynamics, characteristics, and structures, to deconstruct them to their baseline asset level and to understand and compare them. After two different subsectors run through our model, we turn them into similar sets of cash flows that can be analyzed, discussed, and evaluated on a relative basis. That’s active portfolio management.
Our top-down macro thesis is that mortgage credit, as an asset class, is one of the best sources of risk-adjusted returns. But we actively manage the portfolio as evidenced by our sector or subsector allocation and our turnover statistics. If we have the chance to hold yield constant and decrease risk, or hold risk constant and increase yield, we will make that trade. Turnover at the portfolio level is two to three times on an annual basis as we actively manage to drive value.
Q: Who makes the final decision to include an asset in the portfolio?
As a platform, we manage multiple products, including this strategy. As Chief Executive Officer and Chairman of the Investment Committee, I evaluate the portfolio manager on hitting his or her objectives. At the highest level, decisions fall on the portfolio manager, who is supported by sector specialists with significant autonomy within their sectors. So, the portfolio manager makes buy and sell decisions at the sector/subsector level, but the sector specialist is the one analyzing specific bonds.
That’s a transparent, accountable process. The sector specialists own the positions and are held accountable by the portfolio manager to deliver on the instructions they were given. Once purchased, the bond position is monitored for price and performance and is constantly re-evaluated.
Ultimately, from a business and investor perspective, the portfolio manager is responsible for everything that is or is not in the fund. At the position level, the sector specialist is responsible for the evaluation, maintenance, and monitoring of any given position and/or idea.
Q: What is your buy and sell discipline?
On the buy side, there is constant evaluation of relative value. On the sell side, if a bond is performing weak from a relative value perspective, we can be opportunistic and sell it. And from risk mitigation standpoint, if a bond is not performing due to price or collateral behavior, the risk committee can force the sale.
At the time of evaluation and purchase, we analyze every loan that can price a bond. We document dozens of assumptions around how each loan is going to perform. The monthly remittance reports in the market validate or invalidate our initial assumptions, such as did home prices go up in that region or not, did defaults come down or not, did pre-payments stay stable or not, did more people fall from 30-day delinquent to 60-day delinquent or not.
There are dozens of real-time metrics that are reported monthly and allow us to constantly compare how we believe the cash flows would act and how they are actually acting. In conjunction with price movement, that allows us to be vigilant. If the price of a bond falls, there is a forced review of the collateral and re-underwriting of the opportunity set. If the loans in a bond underperform from a credit perspective or assumption set, there is a forced review and re-underwriting of that particular asset.
Our risk committee meets on a weekly basis and there is a constant formal review of the performance of the assets both from price and from collateral perspective.
Q: What is your portfolio construction process?
This is a total return fund with no mandated allocations or limits on allocation to various sectors and subsectors. The only mandated guideline is that the fund needs to be at least 80% in mortgage-backed securities. We have internally driven guidelines that limit the position size to 5% of the fund and the sector allocation to 25% of the fund.
In the construct of searching for relative value, the largest portfolio construction driver is ensuring that we build a portfolio that is appropriate from credit and liquidity perspective.
We think about liquidity across three dimensions. First, we consider liquidity at the bond level. The sector specialists evaluate how long it takes to sell the bond at the mark or right away. That information is filtering up to the portfolio manager. Then, the manager considers laddering the liquidity of the portfolio. For instance, what percentage of the fund should be immediately liquid? And finally, from an operational perspective, we can redeem up to 20% of the fund utilizing a credit line from our custodian bank.
So, the combination of the granular perspective at the bond level, the portfolio manager laddering the liquidity of the portfolio, and the operational credit line allow us to manage liquidity effectively.
The benchmark of the fund is the Barclays Capital U.S. Mortgage Backed Securities Index.
Q: How do you define and manage risk?
At the highest level, avoiding risk is avoiding drawdown or losing capital. For us, there are three levels of risk. The first one is the credit component. Since we make mortgage credit bets, we need to ensure that from a credit perspective the intrinsic value of the cash flows we are buying is not impaired and can perform in various forward looking scenarios. So, we have a heavy focus and a bottom-up perspective on the credit component of what we buy, centered on our loan level credit model.
The second component is technical risk, which can drive pressure on various asset classes. The factors that go in this analysis are performance of mortgages, falling stock market, geopolitical risk, rising interest rates, bond market sell off, etc.
The third component is liquidity risk. Because this is an over-the-counter sector, we never want to be forced to sell a bond at the wrong time. So, we manage risk across three dimensions - credit, technical and liquidity. The portfolio managers construct the portfolio and select bond based on the three type risks that they manage around.
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