Flexibility in Structured Finance
Braddock Multi-Strategy Income Fund
Author: Ticker Magazine
Last Update: Sep 08, 10:58 AM EDT
|Asset-backed securities, including mortgage-backed securities, are a special area of the fixed-income space that demands specialized knowledge and experience in credit markets and the economy. Garrett Tripp, portfolio manager of the Braddock Multi-Strategy Income Fund, relies on a flexible and opportunistic approach to find securities that offer the best risk-reward profile.
“Our approach to investing can be described as opportunistic in that we seek investments offering the best risk-reward profile.”
Q: What is the history of the fund?
Braddock Financial, LLC was founded by Harvey Allon in 1994. Mr. Allon, who had managed the Residential Mortgage Backed Securities (RMBS) trading desk at Nomura Securities, is considered one of the pioneers in the mortgage and structured finance space. In the late 1990s, he started investing in mezzanine and subordinated debt, primarily RMBS securities.
The Braddock Multi-Strategy Income Fund (the “Fund”) started on July 31, 2009 and was our first foray into the mutual fund industry. Initially, the fund was private, but at the end of 2015, we opened it to the public. Braddock Financial, LLC is the fund’s sub-advisor.
Q: What is your definition of multi-strategy?
Our objective is to make money from both income and capital appreciation. Basically, we are a fixed-income fund with the flexibility to invest across the structured finance markets. While we are primarily focused on RMBS, we also invest in the Asset Backed Securities (ABS), Collateralized Loan Obligations (CLOs), and Commercial Mortgage-Backed securities (CMBS).
Our definition of multi-strategy is a fund that has ability to alter its allocations to various segments of the structured finance market depending on market conditions. This is expanded by our ability to invest up and down the capital stack (Investment and Non-investment grade bonds). The Fund also has the ability to hedge its long positions in periods of high market volatility. It should be noted, we do not invest in dividend-paying or preferred stocks, so the fund has no equity exposure.
Q: What core beliefs guide your investment philosophy?
Our approach to investing can be described as opportunistic in that we seek investments offering the best risk-reward profile. We analyze the current state of the market cycle and the behavior of other buyers and sellers. Then we position ourselves to capitalize on gains from sectors that are trading out of line with our view of their market value.
Keeping abreast of the macro environment is also an important part of our investment strategy. Estimates of economic growth and the expected shape of the yield curve are always factored into our investment decisions.
For example, if we were to believe that interest rates will increase at a slow pace in the near term, we will increase our exposure to floating-rate securities. Then, if we were correct and short term interest rates increased 100 basis points, the coupons of the floating rate bonds indexed to short-term indices in our portfolio would correspondingly increase.
At this moment, we are keeping our effective duration, or interest rate exposure, very short due to the high floating-rate nature of the bonds in the fund.
In the three-to-five-year period, if we believed that interest rates were going to flatten out, or perhaps even fall, we would invest in a more balanced spread between fixed and floating-rate securities.
Q: What is your investment process?
We are a fundamentally based investing shop. Our bottom-up approach is aimed at identifying securities that offer the best risk-reward profile considering both the underlying collateral and the structure of a fixed income investment.
Early on, Braddock realized the importance of having access to good fundamental data. So, we built a mortgage, loan-level database, which contained millions of mortgages with detailed information on how the loans have performed month-by-month since their initial origination. We use that tool to better assess the underlying value of the mortgages based on location, socioeconomic status, and type of loan.
The overall process includes numerous scenario and sensitivity tests of each potential investment and its effect on the overall portfolio.
Given our yield curve expectations and top-down evaluation of the U.S. housing and consumer sectors, we undertake a risk management process that analyzes the relationships between our markets and corporate credit spreads across the investment grade and high-yield market. Using a weighted average procedure, we evaluated credit spread risk to form a risk perspective for which we are comfortable.
Q: Who issues the floating-rate bonds?
In the structured finance space, you are dealing with pools of loans that have been sold into a bankruptcy remote trust. The bonds issued by the trust can either be fixed or floating-rate. As floating rate bonds, the coupons paid are usually indexed to the one or three-month LIBOR rates plus a spread. Alternatively, they may be a pass through of the average mortgage rate paid on the underlying loans which is called the weighted average coupon.
Q: How do you assess credit quality?
We buy roughly an equal split between seasoned bonds in the secondary market and newly issued bonds. The analysis we use in evaluating the bonds varies between the two types.
For the seasoned securities, we use our loan-level database to determine the actual performance to date of every loan backing the security. We can see how many mortgages are current, delinquent, or have been modified due to a borrower’s financial hardship. If a loan is in foreclosure, we can evaluate whether it is likely to lead to a loss and what impact that loss will have on the bond’s risk, volatility, and underlying cash flow.
On the new issue side, which we consider as a security issued after the financial crisis, we evaluate both the loan originator and the associated underwriting guidelines to see if we believe their guidelines are appropriate.
In particular, we check that the originators are doing full documentation on the underlying borrowers: verifying income; making sure the appraisal is correct; and checking if the product fits the borrower. In the wake of the financial crisis, there is a whole set of new rules to ensure that the borrower has the ability to repay the loan.
Finally, we forecast prepayment and default rates of the loans over the life of the trust. That helps us decide which bond provides the best risk-reward profile.