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Q&As and Interviews
Kiril Nikolaev Apr 29, 2016
Brad Friedlander (B.F.): I started my career against the grain of the equity internet bubble in the late 90s and joined J.P. Morgan’s bond trading desk, where I began to develop a specialization in the mortgage bond market. In the early 2000s, I moved on to WaMu in Seattle in what ironically turned out to be the early stages of a housing bubble. While at WaMu, I managed a diverse portfolio of fixed-income assets with a heavy concentration in asset-backed securities and mortgage-related investments. It wasn’t long before our team began seeing excess risk being taken in the real estate and corresponding bond markets.
As so many of us experienced firsthand, the bubble ultimately burst in 2008. Rather than short the housing market (and essentially American homeowners) as the protagonists of the “Big Short” did in anticipation of a looming crisis wrought with overreaction, we left WaMu in early 2008, six months before Lehman filed for bankruptcy.
In the spring of 2008, I moved to Atlanta and along with co-founder Sreeni Prabhu (also from WaMu), we started Angel Oak as a limited partnership; essentially a long credit hedge fund. Angel Oak continues to manage our limited partnership platform in concert with our three public mutual funds. Currently, the firm’s total AUM is $5.5 billion.
B.F.: ANGIX and ANFIX are unique in that they are alternatives to traditional fixed-income funds. They both carry high current income and low sensitivity to interest rate movements. The funds are unique in that they offer investors access to alternative instruments within the fixed-income world that have a low correlation to equities and other traditional fixed-income investments.
While ANGIX is more focused on mortgage credit, ANFIX is built around corporate credit alternatives.
B.F.: ANGIX is largely a mortgage strategy designed to capitalize on the fundamental improvement in U.S. housing. The fund is poised to take advantage of a value dislocation in these mortgage bonds that still exists today. Consistent improvement in housing fundamentals is a tailwind and an important piece of our economy. Nearly 70% of the fund is invested in residential and commercial non-agency mortgage bonds; thus, ANGIX provides investors with a tool to access markets that represent value, but tend to be smaller allocations within large traditional bond funds.
ANFIX is more focused on corporate credit and is oriented with 75% of its holdings in that sector. Collateralized loan obligations (CLOs) make up approximately 40% of the fund while approximately 30% is allocated to regional financial corporate debt. ANFIX is about providing investors with access to alternatives corporate debt (like investment-grade and high-yield) without the noise of interest rate risk.
B.F.: Virtually all credit markets experienced weakness that started to germinate in the early to middle part of 2015 and carried all the way through the first quarter of 2016. This broad weakness was driven by commodity and energy price concerns as well as global growth fears, but the stress bled into traditional risk assets such as equities and fixed income. The structured credit markets that ANFIX invests in were largely insulated from the first wave of market weakness in the second half of 2015, as demonstrated by a positive total return for the year; however, the extent and shear duration of the weakness in high-yield debt led to similar drawdowns in CLOs that peaked in January/February of this year.
B.F.: By the middle of February, the market had become egregiously pessimistic about corporate credit defaults and the odds of encountering a U.S. recession. The market was pricing in a level of loan defaults twice as high as what we saw during the recession. Simultaneously, markets were pricing in a mass redemption and forced selling event within the corporate bond world. CLOs saw yields climb into the high single/low double digits. The markets clearly overreacted, but since then they’ve begun moving back to equilibrium. Despite this modest recovery, CLO valuations have lagged the recovery we’ve seen in other assets, so we believe there is still plenty of upside potential given the risk.
B.F.: Our funds are best suited for income- and value-oriented investors looking to take advantage of still existing dislocations within the credit markets without incurring excessive interest rate risk. Investors should always consult their investment advisor to make sure the funds are suitable for their overall investment approach.
B.F.: The vast majority of fixed income will continue to face challenges over the next several years. We expect rates to remain low and the market certainly expects this as well. Current prices reflect that the market has priced in one more rate hike for 2016; however, I believe that we could see slightly more aggressive Federal Reserve action compared to what a rather complacent market is anticipating.
Thankfully, whether the Fed moves one, two or three times this year is not something that is significant to our interest rate agnostic approach.
B.F.: Living in a low rate, low income world with weak to mediocre growth and tremendous uncertainty is going to be a real challenge for investors. Our approach to credit investing may provide income to carry through this uncertainty and the opportunity to take advantage of value misperceptions over time.
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