As fund managers interacting with our clients, the team often gets asked, “What’s the holding period for a trade”? And, given our strong belief in active management, we typically respond by explaining how we rotate our portfolios’ credit and rates exposure across issuer / sector / quality / currency to find the best value in the market. It’s not often we say “six years” and leave it as that.
But for those of you that have followed our strategic bond funds over the years, you will have noticed that we recently closed our long-held position in US Non-Agency Residential Mortgage Backed Securities (RMBS).
The aftermath of the great financial crisis created many opportunities for us as active managers. One of these transpired back in the summer of 2011, when we started to establish a position in US RMBS. These were bonds secured on pools of US mortgages that had been originated in the years 2006 and 2007 and were trading at very distressed prices (on average in the low 60 cents in the dollar). This reflected a US housing market still in a state of flux following the financial crisis, and an expectation that these bonds would experience losses as home owners defaulted on their mortgages.
At the time we believed that the pricing of the bonds reflected too pessimistic an outlook for the US housing market, pricing in significant further declines in average home prices. In our opinion, we were nearing the bottom of the housing cycle, and these bonds would perform well as the US housing market recovered. With the benefit of hindsight, we were six months too early in our entry point as US house prices didn’t trough until late 2011/early 2012. But as long-term investors and given the scale of the subsequent recovery, it is harsh to quibble about the exact timing.
We recently took the decision to exit this position. With average US prices now above the level they were before the financial crisis, we believe we have seen the bulk of the performance from the trade. That is not to say we believe there will be a downturn in US house prices, rather the bonds now more accurately reflect the outlook.
One of the skills we must have as active managers is the discipline to take profits on a successful trade. These bonds have been an excellent investment for our clients, with some positions generating an average return of close to 8% each year since our initial entry. They have also provided excellent diversification benefits for the funds, exhibiting very little correlation with other parts of the global fixed income market. In this case, it was well worth an extension to our typical holding period of a trade.