Q: Could you give us an overview of the fund?

The fund is fixed income and, more specifically, the vast majority of the risk we take is focused on the securitized credit portions of the market. It is important to note that about 80% of total securitized supply comes with government guarantees. Our fund is more focused on the part of the market that doesn’t have that guarantee, so credit risk is the dominant form of risk that we take.

The fund is relatively new, since August, 2015. The launch of the fund followed a long period of time, when our team was managing securitized credit assets on behalf of Voya and its predecessor, ING. For us, the fund is another way to deliver securitized credit solutions to the investors, who cannot access the securitized credit markets on their own or via a separate account, or otherwise prefer a commingled, easy to access investment vehicle.

Q: What differentiates your fund from its peers?

One unique feature is that our fund has meaningful amounts of exposure across the securitized credit universe, including in Asset-Backed Securities (ABS), Collateralized Loan Obligations (CLOs), commercial mortgage-backed securities (CMBS), and Residential Mortgage-Backed Securities (RMBS).

Another differentiator is that we attempt to maintain a portfolio that will generate returns through the cycle, as opposed to focusing on trades with finite investment horizons. The credit crisis, which created distortion in the fixed income markets, also caused a generational opportunity. Many mutual fund managers harness that opportunity in a focused way, while we think that securitized credit markets can be harnessed through the cycle. I believe that our approach is unique because of the complete usage of all the securitized groups in a diversified way, with the goal for through-the-cycle outperformance.

Lastly, we differ from our peer group by maintaining focus solely on securitized credit, and doing so with the strength of an institutional quality, top tier sponsor like Voya.

Q: What are the core beliefs behind your investment philosophy?

The key tenets of our philosophy are reflected in the way we have built our investment platform. First, we believe that our markets are dynamic. They can and do change rapidly, so the managers in the space need to have a dynamic approach, to be nimble, and to be prepared for constant change. Therefore, our process is designed to be dynamic and balanced.

There are two separate ways in which we balance the fund. First, we consider the top-down drivers of risk taking in our market as well as the bottom-up drivers. Second, we balance the use of qualitative versus quantitative information. In some cases, we rely on more subjective information versus the quantitative, statistically-based data, which is readily available in securitized markets. It depends on what we believe drives value at the time. We have to be able to balance the inputs, which have varying degrees of merit and relevance at the particular time. We believe that by balancing the inputs, we can best take advantage of the markets will continue to change rapidly over the course of a cycle.

Another key aspect of our philosophy is that risk management is at the forefront. We view ourselves as investors as being the first line of defense from a risk standpoint for our clients. Now, we have powerful partners internally as an independently reporting risk team, but ultimately, we believe that our securitized investors, or risk takers, have to be effective risk managers. We do not seek equity-oriented risk taking in our approach. Instead, we aim to provide a consistently good, reliable source of positive returns for our clients.

We recognize that one of the most efficient ways to manage risk is diversification and we constantly seek for ways to manage concentrations and further diversify our portfolio risks. Markets can move quickly and our upside/downside can change fast, so we are constantly trying to mitigate that, with diversification a key tenant.

Q: What is your investment process?

There are three key steps of the process before we include the right ideas in the portfolio. They should not be thought of as sequential steps, but are constantly working together. One part of our process is refining our view on the universe from a top-down macro perspective. We try to assess all the different macro forces that will impact the risk in our market. From these inputs, we can spawn micro ideas, with specific cusips in the securitized markets that can have an impact on the portfolio, or it can of course influence higher level sector positioning from a macro perspective.

On the other side of the equation is our bottom-up process. That part includes assessing factors that drive the security selection in the securitized credit market and narrowing down the universe from tens of thousands of securities to the precious few that are good enough to hold in the fund for our investors. So, while there is a top-down element that can drive micro ideas, the bottom-up aspect provides a natural and typically more directly relevant set of inputs for our security selection decisions.

As an aside, the majority of our platform costs are tied to making the correct security selection decisions. We view this as our primary responsibility to judge correctly, both at the time of investment and every day we own the position.

Bottom line, the top-down inputs and the bottom-up factors, when correctly assessed, provide the team with the valuable levers to optimize the chance for through the cycle success for our investors.

The third part of the process is constructing the portfolio and balancing the top-down inputs with the bottom-up parts in a seamless way. We can’t make mistakes from a compliance or risk perspective. The idea of the portfolio construction is to tie everything together in a balanced way, which properly reflects real information and the risks we intend to take. In this vein we are also considering the constraints that we have in the mutual fund construct.

Q: How is your team organized?

Each of our team members is not only a researcher, but also a trader. We don’t divide the labor by function; we segment the team by sectors. Different individuals are focused on different parts of the market, such as ABS, RMBS, CLOs, or CMBS. That’s the design of our structure and we think it is critical. We have owned many of the bonds since inception and we’ll likely continue to do so. In many cases these bonds have been outstanding and traded for more than 10 years with the same collateral. So, we believe that it is really important to have a seamless approach to both research and trading.

Q: How do you narrow down the universe to select securities? Could you give us some examples?

A good example would be the credit risk transfer, or CRT. It is a relatively new part of the securitized credit universe, which confirms the philosophy that securitized markets are extremely dynamic and fluid. The CRT market just started in the last 5 years and now is a self-sustaining, living and breathing capital market in its own right.

In our approach, we make sure that the investments make sense from an asset allocation standpoint. When selecting the right securities in a relatively new market, a key factor is having a team with dedicated experience. On the securitized credit side, we have a team of eight people, including myself, and most of us have traded together since before the credit crisis. We have a lot of understanding of the types of risks or structures that can perform through the cycle, and we felt that CRT had the hallmarks of the specific risk type.

At the security level, the assessment has several dimensions. In terms of risk and valuation, the collateral comes first. Within the CRT sector, we actually take the loan-level data to review the risk in this asset class. The second dimension is structure. We have to be able to analyze the structures, to understand the priority of payments, the cash flow, what part of the capital structure has the lowest priority, the most risk and the most leverage to that collateral. When structure and collateral come together, we can make the optimal risk/reward assessment to invest in the securitized bond.

As part of the analysis of the CRT structure, we evaluate how much subordination we have and what our priority of payment in the capital structure is related to that collateral. In some cases, when we have positive view on the collateral, we may be willing to accept less structure because we believe we will be compensated for taking more collateral risk. The goal of the assessment is to secure a positive outcome for the investors and long-term outperformance.

The third dimension is evaluation of the parties involved, because we don’t want the risk associated with the underlying corporate entities to negatively or otherwise unduly affect us. So we spend time evaluating the various entities that somehow impact the cash flow associated with the collateral. These parties could be the originators or the servicers of the assets, the rating agencies involved and even the distributing counterparties of the bonds themselves. In the case of CLOs, to use another example, it could be the actual manager of the assets.

Q: Do you use a ranking system, internal or external?

In the securitized credit markets, a one size fits all ranking system just isn’t feasible if one is seeking consistent outperformance. The notion of ranking is perhaps more applicable in an equity or corporate credit construct. In the securitized credit markets, there are some many combinations of risk factors with all the dimensions involved, namely collateral, structure and third parties. Every year we have new issuance on top of an older issuance and varying degrees of collateral seasoning. All these moving parts make a ranking system inherently ineffective; we would be crippled trying to keep the ranking right and we would be more likely to make a bad investment decision over time.

Ultimately, we aim to develop the sweet spot between the collateral biases that we have developed over time, the structural biases, and the issuer, third-party or manager biases. It is important how those come together in the market and where they intersect. That’s the type of risk that we want to invest in.

Q: What is your decision-making process?

We have three portfolio managers, who are responsible for the securities that get in the portfolio. That’s one level of authority and responsibility, but typically the decisions are made in real time. In such dynamic markets, we need to be in a position to take advantage of the rapid changes and be nimble. So, decisions have to be made in real time.

When we make an investment in a bond, it doesn’t necessarily happen every Monday at 8:00 a.m. It is a real-time, highly fluid process. As specialists, we constantly look for opportunities and make real-time observations at the security level, so we may decide to sell. To optimize the security selection in this market, we must be able to transact on any given business day from 7:30 in the morning to 6 o’clock at night.

From an asset allocation point of view, I see my role as ensuring that we are in the best position to succeed, based on allocation to the major food groups that we own at any given time. When changing allocations, we are more pragmatic and rely more on longer-term, top-down observations than on the dynamic fluid movements that tend to dictate security selection decisions.

We tend to be more stable with our asset allocations. When we make changes, we have a process that aims to ensure stability, although we are constantly looking for changes that may occur more rapidly. Ultimately, while I own the final asset allocation decision, it is based on all of the inputs that I receive from my teammates, so we have a consensus-oriented asset allocation process.

Q: How do you construct the portfolio?

Diversification is a great way to reduce idiosyncratic risk and, therefore, to optimize the chances for consistent, repeatable success. We emphasize diversification at several levels. At the asset-allocation level, we consider exposure to the complete footprint, because of our expertise in each of the major groups. So, we are diversified and we optimize the mix of our investments. We never just blindly allocate to a space; we are always thoughtful as we base our positioning on our top-down, bottom-up process.

At the security selection level, within each of the major food groups we take risk across the three dimensions – collateral, structure, and involved parties - in a diversified way. We are cognizant of how much risk we have on aggregate, so we wouldn’t have too much of the same type of collateral.

For the specific types of collateral we want, we diversify versus other dimensions, such as, in the CRT universe, low versus high loan-to-value, or LTV, and more recently high versus low debt-to-income. Then we start with the layered risks of the high LTV bars paired with potentially high DTIs. We work all these different dimensions on the collateral level making sure we diversify risks from that perspective.

From a structural perspective, we diversify within the capital structure of the deals. So we can express varying degrees of structural protection in the portfolio within the capital structure and achieve more diversification. From the perspective of involved parties, we make sure that we don’t overly invest in bonds from a particular issuer. Overall, we constantly use diversification because we believe that it gives the best chance to outperform through the cycle.

Q: Do you invest in U.S. domestic bonds only?

We invest in U.S. dollar denominated bonds, although we may sometimes evaluate opportunities where the underlying collateral is denominated in a different currency. We are open to such opportunities if they emerge, but the vast majority of our holdings are consistently based in the U.S.

Q: Which benchmark do you use? Do you have restrictions on position sizes at the security or the sector level?

We allude to a benchmark, although there’s not a great, well-known benchmark that is accessible for investors in the securitized credit space. We seek to outperform through a cycle of the securitized portion of the Bloomberg Barclays U.S. Aggregate Bond Index, but it is not the best representation of the market. We believe that there are better ways to assess and manage behavior. We have found that the return performance and the amount of volatility that we’ve provided relative to that return are better ways for investors to assess our performance, as opposed to how soundly we beat the benchmark.

We have some internally imposed limits, such as 5% maximum CUSIP allocation and a 20% issuer limit. However, we endeavor to maintain flexibility and we make sure that the clients have a gauge of where exactly they want to take risk.

Q: How do you define and manage risk?

Our definition of risk is anything that generates uncertainty about the potential investment. In other words, what are the sources of uncertainty as you underwrite the bond? If everything in that bond is certain, it is likely to have very low return.

Technically, the biggest types of risks that we take are credit and interest rate risks. Interest rates directly create risk in our investments and indirectly in the securitized bonds, because the rate environment impacts the willingness and the capacity of the borrowers to repay the loans, and strongly influence prepayment risk. That affects the cash flow decision and creates uncertainty and risk around the bond’s valuation. We are also wary and mindful of the liquidity risk in the market.

Q: Do you believe that the present situation is a good time to invest in the securitized market?

From a relative risk/reward basis, yes. In 2012, we had outsized returns, but there was a lot more risk than where we stand today. Today, now 10 years past the credit crisis, direct risks are lower, yet the spread income remains relatively elevated. From a top-down perspective, we look at many factors to assess our position in the cycle for various markets like housing and real estate.

We still think it looks imbalanced relative to the reward we get. There are always macro factors on the horizon that could disrupt the markets periodically, but looking at the underlying fundamentals, I believe that it is a good time to invest with a relatively long runway ahead.