Q: What are the investment objectives of the fund?

Eventide manages differentiated solutions that fill a gap in the marketplace. One such gap is the shortage of opportunities for investors seeking yield but also wanting to invest responsibly by incorporating environmental, social, and governance (ESG) factors. All the funds we manage fall under this values-based umbrella. 

The Eventide Multi-Asset Income Fund was launched on July 15, 2015 with three primary investment objectives: to generate income for shareholders, to seek growth of that income stream, and to maintain the opportunity for capital appreciation within the broader portfolio – all while adhering to our socially-responsible investment philosophy. 

Because most income investors are transitioning from the accumulation stage of their investment lifecycle towards the distribution phase, we are not interested in creating an all fixed-income portfolio focused on yield with little opportunity for appreciation. Instead, the fund invests in securities with the ability to increase distributions over time. 

Our investors want income, but they also tend to have a fairly long runway in retirement. As they are drawing down their assets, they want the appreciation and income growth this fund offers to help offset the pressures of rising costs. 

My background is in running multi-asset income portfolios, and I have also been involved in socially responsible investing for over a decade. After having known the Eventide team for several years, I joined the firm in early 2015 to launch this fund, which is the firm’s third offering. 

Q: What are the tenets of your socially responsible investment philosophy?

At Eventide, investing is ownership, and we take this responsibility seriously. The firm is grounded in the concept of investing in companies that create value in the world and the belief that such organizations tend to be well run. When companies are not solely focused on the short-term interests of shareholders, and instead focus on other stakeholders, it is our belief they will thrive and ultimately reward shareholders over the long run. 

Our approach is twofold. First, we avoid certain securities and industries like tobacco, gambling, the manufacturing of firearms, and pornography. Second, we use a proprietary framework called Business 360 to assess how companies create or extract value, and we prefer to invest in those creating value.

Business 360 is at the core of Eventide’s values-based investment philosophy, and is part of our fundamental analysis. We use it to identify companies that have exhibited an ability to add value in one or more of six key areas: for its customers, employees, supply chain, community, the environment, and society at large. 

So, in looking at how a company might add value to its customers, a metric like its Net Promoter Score (NPS) is quite important. An NPS goes beyond traditional measures of customer satisfaction to gauge the loyalty of an organization’s customers. 

How a company treats employees is equally, if not more, essential. We review employee feedback to see how much they feel valued or satisfied. Metrics like employee turnover also help us evaluate which companies are creating good and equitable workplaces.  

For us, a company is attractive when it views its supply chain holistically, treating suppliers fairly and as partners, not as opportunities to beat up on pricing repeatedly. Also, we scan supply chains for human rights violations and other things we would not be comfortable participating in. 

The environmental footprint left by a company is another ESG factor the fund considers. For instance, if we were looking to invest in utilities in the income space, we would tend to buy ones that are cleaner and less harmful to the environment rather than those with a high percentage of their fleets in coal plants. 

Business 360 also seeks companies with a strong sense of community. We focus on organizations that give back to the communities where they operate, and also pay careful attention to any overseas operations, especially in developing countries that lack strict regulations. There, companies can take advantage of and hurt local communities – for example, through potential bribery or corruption of government officials. 

Finally, we look at each company in its entirety to see how it interacts with all of these stakeholders, and ask the overarching question that guides our philosophy: does the company create value for society, or extract value from society? 

A clear example that illustrates our view is cigarette companies. They sell a product known to harm, if not kill, its users. Though tobacco firms generate economic profits, they put pressure on society and disrupt people’s lives. Because they extract value from society, our funds avoid them.

Companies that are beneficial to society as a whole are attractive to us. Perhaps they’re advancing cleaner sources of power generation, or trying to improve the care of people with debilitating diseases, or even help to cure them. 

Q: How does your multi-asset investment process work?

Our process is fairly involved. It starts with a valuation-based approach, then we try to integrate the Business 360 process, and finally use independent verification to identify the best candidates within each industry. 

Using a broad macro viewpoint, we adopt a three-legged stool approach that assesses leading economic indicators, overall valuation relative to history, and measures of investor sentiment. Investor sentiment is used as a contrary indicator; we tend to be somewhat optimistic when that sentiment is bearish and somewhat cautious when sentiment is enthusiastic. 

The fund has a multi-asset framework. In addition to equities and fixed-income securities, we invest in alternative income categories like REITs, master limited partnerships (MLPs), business development companies (BDCs), and yieldcos, which are companies formed to generate a predictable cash flow through long-term contracts in the clean energy space. We consider all these to be equity-like investments. The fund will also opportunistically buy bonds in companies where we understand the equity well.

Because the fund invests in many asset classes, an important starting point is asset allocation, or determining how defensive or aggressive we want to be. We use a valuation-based framework to determine which asset classes are more or less attractively priced and assign target allocations for each. The fund has flexibility and can opportunistically allocate to areas where we see the most value. Within each asset class, a fundamental investment process is followed to determine target allocations. 

When sourcing ideas internally, a number of valuation-based screens are employed to view metrics specific to each industry. For example, within REITs we look at the Price to Net Asset Value (P/NAV) of underlying real estate holdings, as well as Price to Funds from Operations (P/FFO). From a multiples standpoint, we prefer companies trading below where they have traded historically. 

Q: How do you conduct research across asset classes and sectors?

Along with Business 360, we also rely on third-party partners to do security-level research to identify the best opportunities within industry-specific valuation models. Although Eventide has certain expertise, we do not believe all the best ideas are housed within our walls, so we tap into the knowledge of others with a process we call Masters Select. 

While we are performing our own screening and research, ideas are also sourced from external analysts and portfolio managers who have done an excellent job adding value within their respective industries, as evidenced by their recommendations and estimates forecasts. Masters Select identifies specialists with real industry insight who we believe are better equipped than generalists to add value. 

For example, we like the work of Green Street Advisors, a firm solely focused on REITs. One advantage Green Street offers is that the number of its buy recommendations typically equals the number of its sell recommendations, and they have demonstrated a track record of adding value over time. In contrast, other research providers may produce 100 buy recommendations, 80 hold recommendations, and just one sell recommendation. 

An ideal company for our portfolio would be one that is trading at a cheap valuation and attractive yield relative to historical multiples and relative to peers within its industry. It gets high scores from our Business 360 process, and is also being confirmed as an attractive name from Masters Select or another independent verification. 

As a portfolio manager, I determine how much to have invested in traditional fixed-income, although we outsource management of the fund’s core fixed-income sleeve to Boyd Watterson Asset Management, an institutional fixed-income manager in Cleveland, Ohio.

We provide Boyd Watterson’s portfolio managers a universe of acceptable securities. Its team evaluates these ideas using their own processes in order to decide which bonds to own. The portfolio they run could include mortgage-backed securities, agency bonds, taxable municipal bonds, green bonds, investment-grade corporate bonds, and high-yield corporate bonds. 

In the alternative income bucket, an important part of our investment strategy is writing covered calls or cash-secured puts. In our view, covered-call writing is a way to pre-sell securities, and cash-secured puts present a way to pre-buy securities. Both are used to generate additional income, and both tie into our valuation framework. 

For example, if we feel a name in the fund is relatively richly valued, and its price target is only 5% above where it currently trades, we may write a covered call, selling half or all of our position when the stock exceeds its target. We would receive the call premium for writing the option, and we are comfortable if the stock gets called away because it achieved our price target. 

We write put options against names we would be happy owning at a lower level. For instance, say a utility stock has been identified for the portfolio. Our analysis has determined it has good assets and a strong management team, and it also scores well using our Business 360 approach. 

However, utilities today are trading at rich multiples – recently, they were more than two standard deviations above their historical normal valuations – and this company is no exception. We cannot get comfortable with its valuation. 

To generate income for the fund, we write put options against names like this utility, say 10% or 15% below where it currently trades. If the stock does not sell off, then the fund keeps the premium. But if the stock does sell off, we are obligated to buy at the lower level – but again, this is a level we would be comfortable owning the utility at. 

To ensure we do not incorporate unintended leverage in the fund, we take the cash required to buy a position if an option is exercised, and collateralize it, putting it in a separate account with a custodian so it remains available for this purchase if necessary. 

Q: Would you provide an example that illustrates your research process and how you look for opportunities?

Examining the yieldco space will offer relevant insights into our research process. 

Yieldcos are a relatively new asset class, and in many ways, are similar to REITs or a clean energy version of an MLP. 

Developers of renewable energy assets – which could be a publicly traded utility – must take on significant risk and apply great expertise to bring new hydro-electric, wind, or solar plant projects to fruition, from finding a site, to building the plant, through getting the necessary regulatory approvals and finding a buyer for the power. 

To free up capital, such developers often use a financial model similar to that used by MLPs – just think of the development companies as the general partners and the yieldcos as the limited partners. Developers sell (referred to as “dropping down projects”) to the yieldcos, basically at a lower IRR and free up capital to develop more projects. 

Power purchase agreements (PPAs), or long-term contracts on the power a plant will generate, typically have a fixed-rate power price built into the agreement, so these assets are not subject to fluctuations in the power market. Once fully operational and contracted out, the plants are cash-generating assets; PPAs on new plants are typically signed 20 to 25 years. 

On the surface, these seem to be attractive investments for income investors. Many private investors, big pension plans, and endowments own these assets because once fully contracted, they are relatively low risk. 

In early 2015, as we were getting ready to launch the fund, we looked at several yieldcos. At that time, clean energy was trending higher; agencies and state governments were setting targets mandating greater percentages of power come from renewable assets. 

We saw a way to generate income for investors that we deemed was not only stable, but offered much cleaner energy than the current fleet – the societal benefit we seek. However, yieldcos were trading with incredibly low yields of 2% to 3%. The story was that they were going to grow dividends at a rapid pace and investors were paying a hefty premium for these assets. 

Although these companies had appealing aspects, we had valuation concerns. But when the energy markets started to implode, MLPs collapsed, and yieldcos sold off in tandem. Between mid 2015 and early 2016, they went from being quite expensive to experiencing tremendous volatility; in many instances, stocks were cut in half or more. 

Yieldcos were also exhibiting very high correlation with the price of oil, which made little sense fundamentally – oil is not an input in the assets and due to their PPAs, they had no commodity sensitivity. 

At this point, we saw an opportunity. In addition to performing our own research, we had also started following analysts who specialized in the yieldco space. The market misunderstood yieldcos, and the valuation models historically used to value companies like these came up short. Our Masters Select process helped us better understand and value yieldcos. 

We utilized run-off valuations, a type of analysis that looks at discounted cash flow valuation of currently owned assets and assumes no future growth. With these, we found several yieldcos were trading well below what their assets were worth.

Even when zero growth was factored in, they still had portfolios of attractive cash-generating assets – assets with value in the private marketplace. Their dividend yields were not between 2% and 4% anymore. Actually, they had increased to the 6% to 7% range, and in some cases those levels were even higher. 

The Business 360 case was there as we viewed these companies as enabling the transition towards cleaner energy. We saw valuations get much cheaper, and then we got validation through the Masters Select process where together we tore apart the financials of a few yieldcos to create a worst-case valuation scenario. This gave us confidence that we were buying below fair value. 

The fund began more aggressively accumulating yieldco names in the fourth quarter of 2015 and added more in the first quarter of 2016. Since then, they have recovered nicely; a vicious cycle is now turning into a virtuous cycle. A number of companies have issued equity at accretive levels and are making new acquisitions to grow their portfolios. They have gone from being severely undervalued to what is now closer to fair value. Finally, the dividend growth component of the story that disappeared is starting to become visible again. 

Q: What is your portfolio construction process?

One of the most important things to note is that this is a diversified fund, and to ensure its diversification, the portfolio construction has limits. 

We are limited to a maximum of 25% in one industry group, with an industry group being not as broad as a sector but broader than one specific industry or sub-industry. For example, power generation would be an example of an industry group. 

With respect to 75% of the Fund’s total asset, the fund can invest a maximum of 5% in a single issuer across all the different types of securities in its capital structure. This means if we invest 5% in the equity of a name, we cannot then buy another 5% in its debt and another 5% in its preferred. As of June 30, 2016, none of the fund’s positions exceeded 3%.

Investments in illiquid or private securities are limited to 15% of the fund’s net assets. 

Much of the fund’s diversification comes from the sheer numbers of securities owned. Overall, the portfolio has more than 100 names from different sources. The fixed-income sleeve run by Boyd Watterson, which is currently a little less than 20% of the portfolio, has about 60 bonds. 

On the equity side, there are approximately 65 holdings. In addition, it has 20+ individual names that we bought directly in the corporate or convertible bond space, or that are invested in other funds, ETFs, or preferred stocks. 

Our sell discipline can be triggered by several things. The number-one reason to sell is when a company goes up in value. We are relatively disciplined when it comes to price targets, and as names start to approach or exceed targets, typically position sizes are lightened. Ultimately, if a price exceeds what we think is fair value and has no margin of safety, we exit a position. 

The second reason to sell would be when something happens that makes us uncomfortable from a Business 360 standpoint. For instance, if a company engages in activity that is not consistent with what we are seeking from an ethical or values-based perspective, or if it has a governance issue, we would exit that name. 

Finally, all investors make mistakes, and if we discover our investment thesis is broken we will sell. It is easy for investors to get attached to a thesis and to convince themselves that even though a business is not working out like they thought, the name is so much cheaper now that they should keep holding it. There is danger in this kind of thinking. 

For example, our analysis of yieldcos has shown that their cash-flow streams are relatively stable and not subject to massive swings in power prices. Were we to see massive cyclicality in a yieldco’s cash-flow generation based on changes in merchant power prices, or commodities markets, it would completely invalidate a large part of our investment thesis. 

If any of this occurred, we would likely exit the position, even at a loss, rather than reinvent its thesis on the fly. 

Q: How do you define and manage risk?

Permanent loss of capital is definitely one way to define risk, but investors would be remiss to not also think of risk in terms of volatility. 

We are very cautious about risking capital, but more willing to take on risk in terms of volatility. For instance, though our yieldco investments are in companies with assets backed by stable cash flows, their stock prices are still subject to violent moves.

Simply put, investors unwilling to face any volatility must accept an incredibly low return profile – or more likely, after inflation and fees, a negative return. 

If we wanted no risk of losing capital whatsoever, the portfolio would probably invest in U.S. Treasury bills, which have a negative return after inflation. 

Within fixed-income, as long as we believed there was a high likelihood that a bond would continue to be able to pay its interest payments, its coupons, and ultimately pay back at maturity, we would be comfortable investing in it – even during periods of increased volatility. 

Our funds are monitored daily using internal systems and external portfolio management tools. Together, these provide insight about where risks and correlations are, and how different securities interact. 

Philosophically, we view risk as protecting investor capital, not as trying to sidestep every bump in the market along the way. If volatility-avoidance is what an investor really wants, they will likely have to pick a fund that is not going to generate much in the way of returns.