Plenty of investors ran away from residential mortgage-backed securities (RMBS) after the financial crisis. Garrison Point Capital’s Tom Miner and Garrett Smith, a pair of Lehman Brothers veterans, had other ideas.
Together with Brian Loo, Miner and Smith have built the $1.68 billion AlphaCentric Income Opportunities fund around the idea that RMBS isn’t so scary after all. The team specializes in non-agency RMBS – debt issued by private institutions rather than government agencies. Miner, Smith and Loo buy up older non-agency RMBS, often in small lots from distressed sellers, enabling them to negotiate discounts.
The numbers tell the story: Over the past three years, the AlphaCentric Income Opportunities fund has returned 40.1%. The average manager in the multi-sector bond category has returned just 8.2% over that period, while the Bloomberg Barclays US Aggregate Bond index has returned 4.2%.
These numbers come with a caveat though. The fund is essentially all RMBS, unlike most other funds in the multi-sector peer group. Aside from small allocations to US Treasury bonds (4.4%) and cash (1.1%), 93.6% of the portfolio is devoted to RMBS.
David versus Goliath
The next best fund in the category for three-year total returns is the ubiquitous $112.2 billion Pimco Income fund, which had an 8.5% allocation to non-agency RMBS at the end of the first quarter, according to data from Morningstar.
Few funds can match the Pimco Income strategy for scale, but the Garrison Point managers see their small size as an advantage. ‘We have been small enough to be nimble and take advantage of opportunities that the big guys haven’t been able to,’ Smith said. ‘And I have to give us a little bit of credit – I think we’ve selected the right bonds. Hopefully we have added a little alpha on top of being in the right sector.’
It all started back in 2009. Smith was working with high-net-worth clients at Barclays following the Lehman Brothers bankruptcy, and Miner had stepped away from running Lehman’s securitized products business on the West Coast two years earlier to focus on managing a start-up that manufactured folding bikes and high-end scooters.
‘Garrett called me up in early ’09 and said, “There’s this great opportunity in the non-agency space. You’ve structured all these deals and you understand how they work. Any interest in joining me at Barclays to take advantage of this amazing opportunity?”’ Miner recalled. ‘He really just put a face on that opportunity. The housing market had dropped 35%, but the securities that were backed by the housing market had dropped by between 60% and 80%. There was really no reason for them to have dropped that much more than the housing market, because these were the assets that the securities were backed by.’
Miner and Smith left Barclays in 2012 to go independent, founding Garrison Point Capital in Walnut Creek, California. They added Loo from TCW soon after launch and originally focused on separately managed accounts and hedge funds.
In 2015, they partnered with AlphaCentric, a joint venture between mutual fund marketing firm Multi-Funds and MFund Distributors. Most of AlphaCentric’s other funds, such as its $9.75 million AlphaCentric Bond Rotation fund and its $12.04 million AlphaCentric Asset Rotation fund, are managed by subadvisors, and Garrison Point joined their ranks.
‘Multi-Funds knew a lot about the mortgage-backed security space from a marketing standpoint and wanted to find another advisor to do that under the AlphaCentric umbrella,’ Smith said. ‘We had been contemplating launching a mutual fund ourselves, so it was fortuitous for both of us.’
Back in the game
When Miner and Smith were first buying up small lots of RMBS, they faced relatively little competition. These days, it seems as though the rest of the industry has caught on too.
‘Practically every fund manager that you can think of is involved in some way in this sector. Pimco has more than $100 billion of this type of paper,’ Miner said. ‘Because they’re so big, they’re not able to get it into their funds in a concentrated way.’
The non-agency RMBS market still bears some scars from the financial crisis. Miner estimated that the market has shrunk from $3 trillion or $4 trillion in 2009 to around $400 billion today. Most of the surviving securities lost investment grade status years ago, and the credit rating agencies aren’t likely to re-examine them soon.
That’s no matter to the Garrison Point team though. ‘It’s actually something that we don’t think is terribly relevant right now,’ Smith said. ‘When they rate these securities, they rate them on the probability of getting back 100 cents on the dollar. They’re not rating their purchase price. The average purchase price for us in this fund is in the low 60s.’