This month, we’re pleased to announce the launch of the Ninepoint Alternative Credit Opportunities Fund, a Liquid Alternative fund for investors who want access to a flexible credit strategy.
We now have a range of innovative fixed income solutions that offer investors more opportunities for income, greater flexibility to generate returns, and excellent portfolio diversification properties:
Just like we do every month, we will review changes to the Diversified Bond and Credit Income Opportunities Funds, and then will focus on the new Liquid Alt product, the Ninepoint Alternative Credit Opportunities Fund, discussing how this fund differs from our other mandates and how we expect it will behave in different market environments.
May was another good month for the Diversified Bond Fund (DBF), returning 44bps. As discussed last month, with poorer than expected economic data and expectations for Fed rate hikes having moderated, there has been a small decline in interest rates. We are mostly done extending the duration of our credit, with perhaps another 10-15% of the fund in short-dated positions that we may extend, should conditions be favourable. We have modestly increased our HY allocation, mostly driven by additions to hybrid bonds of IG corporates. Following month-end, we have slightly decreased our short position in government bonds, taking profits on 30-year corporates that were interest rate hedged.
Finally, with implied volatility very low and HY index credit spreads at the tights, we have initiated small option hedge in HYG, which we expect to modestly grow in the coming months. While we are not overly concerned with where valuations are and given how cheap hedges are, we think it is the prudent thing to do.
It was another good month for the OM fund, returning 96bps. We did not make substantial changes to the portfolio, with the exception of having initiated a HYG hedge, similar to the one discussed above in our mutual fund, the Diversified Bond Fund.
Performance of the OM product as at May 31, 2021 can be seen below:
As we launch our new Liquid Alternative, the Ninepoint Alternative Credit Opportunities Fund, investors can now take advantage of a strategy that features daily pricing and liquidity, in addition to the convenience of an ETF class. Given our style and risk management framework, most of the strategies used by our OM fund are available to our new Liquid Alt.
The best way to think about the Liquid Alt’s portfolio is through the schematic below:
To effectively execute this strategy, we essentially run two different portfolios that, once combined, produce enhanced income and return. We refer to them as the Core, and the Overlay.
The Core portfolio consists of the same type of securities we would typically own in our mutual fund, the Diversified Bond Fund (DBF): corporate bonds, high yield bonds, hybrid securities (e.g., preferred shares, LRCN, hybrid bonds, asset backed securities, etc.) and portfolio hedges. But there are a few important differences between our Liquid Alt Core portfolio and the DBF:
a) Duration: in the DBF, we actively alter the duration of securities depending on the macroeconomic environment. In our Liquid Alt Core portfolio, the duration of the securities we buy is modest, typically ranging between one and five years. We would very rarely buy government bonds in the Liquid Alt Core portfolio. Our focus is primarily credit.
b) Hybrid Securities: We make greater use of hybrid securities in the Liquid Alt Core portfolio than in the DBF. These securities are lower in the capital structure but yield significantly more than most investment grade quality credit. As we have a higher risk tolerance in our Liquid Alt fund than in the DBF, we are comfortable having a bigger weight.
c) Illiquid Securities: mutual fund rules allow us up to 10% of NAV in illiquid securities. In the DBF, we do not make much use of this illiquid bucket as we target higher liquidity and lower volatility, but in the Liquid Alt Core portfolio, we will include a small sleeve of less liquid securities such as bespoke loans, structured notes, and over-the-counter derivatives. From a credit perspective, these securities aren’t riskier – they are simply harder to liquidate in volatile markets.
d) Hedging: since there is less duration utilized in this portfolio, we use less active hedging duration in the Liquid Alt Core portfolio than we would in the DBF. However, due to a higher concentration of credit securities and the absence of government bonds in the Liquid Alt fund, we naturally need to employ more credit hedges. Like the DBF, we use options on fixed income ETFs such as HYG, LQD and JNK, but we will also be using Credit Default Swaps (CDS) indices and their options to hedge credit risk more directly. The advantage of using CDS is that they carry very little duration (as opposed to the ETFs) and allow us to directly hedge investment grade credit risk (LQD has too much duration). So overall, a more active and targeted credit hedging program is used in the Liquid Alt, to reflect the higher concentration of credit the fund holds.
Depending on market conditions, we expect this Liquid Alt Core portfolio to yield between 3% and 5% with a duration of between one and five years. This Core portfolio typically represents between 95% to 100% of NAV.
The Overlay portfolio, as its name implies, is where we employ leverage, a crucial tool afforded to us by the Liquid Alternative rules. The bulk of the Liquid Alt Overlay consists of high-quality investment grade bonds of intermediate duration (4 to 10 years), where the duration is hedged by shorting the associated benchmark government bond (Figure 2). Shorting a government bond achieves two things: it generates cash to buy the corporate bond and it immunizes the portfolio from interest rate risk (i.e. duration). So essentially, the Liquid Alt Overlay is a diverse and laddered portfolio of investment grade corporate bonds where we hedge all the interest rate sensitivity. The Overlay portfolio then earns the Credit Spread.
In the Liquid Alt Overlay, we also have the ability to short corporate or high yield bonds outright, if we believe that they are overvalued. We also enter into carry trades where, for example, a bond gets called and we fund the position for a month or two.
A word on leverage: we have managed leveraged credit strategies throughout several market cycles, starting with the Great Financial Crisis in 2008, and have had firsthand experience on how damaging excessive leverage can be. We believe that it's prudent to use a moderate amount of leverage in our Liquid Alt strategy, on average between 0.5x to 1.5x. We have found that, over time, this amount of leverage, along with our other risk management strategies, maximises return without incurring excessive volatility and drawdowns.
So, like the DBF, we strategically alter the characteristics of the Liquid Alt Overlay portfolio to be opportunistic or defensive, and the amount of leverage used is just one of the many levers we have at our disposal to alter credit risk in the portfolio.
On average, over time, we expect the Liquid Alt Overlay portfolio to generate between 2% to 3% of yield, with no duration risk.
Putting it all together, the Core plus the Overlay portfolios, gets us to the Alternative Credit Opportunities Fund, where we expect total portfolio yield to be in the range of 5% to 8%, with duration in the range of 1 to 5 years.
We find that this strategy performs well in all interest rate environments (e.g. rising or declining rates) and that, because of our active risk management and hedging, we can handle many different market gyrations without incurring unacceptable drawdowns. Drawing from our experience with our OM fund, we expect that our Liquid Alt strategy will not exhibit a very high beta or correlation with traditional fixed income or high yield, making it a strong potential alternative and portfolio diversifier.
As we have done with our other funds, we will publish the following table every month in this commentary, so investors can keep track of changes to the portfolio positioning:
To learn more about the Ninepoint Alternative Credit Opportunities Fund, you can also listen to a webinar we hosted earlier this month: A High-Net-Worth Strategy for Every Portfolio (listen here).
The environment continues to be conducive to our strategies and we are appropriately positioned. We do not foresee a drastic change to positioning until we start getting closer to the Jackson Hole Symposium in August, where we expect the Fed to start talking about QE tapering.
Mark & Etienne
1 All Ninepoint Diversified Bond Fund/Class returns and fund details are a) based on Series F units; b) net of fees; c) annualized if period is greater than one year; d) as at May 31, 2021 1 All Ninepoint Credit Income Opportunities Fund returns and fund details are a) based on Class F units (closed to subscriptions); b) net of fees; c) annualized if period is greater than one year; d) as at May 31, 2021.
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