DD Summary of our visit to Reams Asset Management in Q4/2014

 

Summary:

Our recent visit to Reams Asset Management in Columbus, Indiana cemented our belief that they are judicious stewards of your clients’ wealth.  In a world where investors are chasing yield at all corners of the globe, 2014 was a year of caution for Reams.

With the view that either treasury yields are too low or credit spreads are too tight, Reams has spent much of the year with significant amounts of cash, allowing them to be prepared to take advantage of the volatility that is surely coming in fixed income markets.

Despite yields being 35% (10 year from 3.05 to under 2%) lower than they were at the beginning of 2014, many investors are still positioned with the majority of their fixed income in index sensitive strategies.

Whether the Fed acts to raise rates at all in 2015, the chart below shows that buying bonds at these levels, for the long-term, almost certainly ensures negative returns in real terms (thank you Ben Carlson @awealthofcs.)

 

Why Do I own this Fund?

  • Investors who own this fund recognize that we are near historical lows for interest rates, and that an index based approach could lead to capital losses in the coming years.
  • They are looking for an active management team with a long history of adding value in fixed income markets, including during periods of rising interest rates and heightened volatility.
  • Advisors who have recommended this fund, recognize that it provides significant diversification and ultimately a ‘hedge’ to traditional fixed income strategies.

 

What Drives Us:

Our focus at Redwood is to partner with boutique investment managers and deliver unique investment solutions tailored to Canadian clients.

Our approach is perhaps best exemplified by the Redwood Unconstrained Bond Fund.

Managed by specialist fixed income manager Reams Asset Management, who manage almost $20 billion in fixed income assets from their offices in Columbus, Indiana, the company exemplifies what we seek out in an investment boutique

Reams has a track record dating back to 1981 utilizing their unique, volatility approach to managing fixed income investments.  Their approach can be compared to that of a value-oriented equity fund manager.  They are buyers of fixed income securities, when they believe that there is relative value, and they are convinced that there is no risk of permanent loss of capital.

Reams was founded with an unconstrained, flexible investment approach.  Through the 80s and 90s, the firm began conforming to the ‘style boxes’ of asset and pension consultants.  The firm relaunched a dedicated unconstrained product in 1998.

Firm Overview:

  • Reams was founded in 1981, and was spun out of Cummins. The founders of Reams were employees of the pension management group for the company.
  • Reams is named after company founder, Fred Reams, who was actually an equity portfolio manager.
  • 13 investment professional, with average investment experience of 19 years.
  • Over CDN$20 billion in AUM, managing on behalf of institutions, and as sub-advisors to Redwood, Scout Investments, Russell Investments, Jackson Life and Prudential.

Strategy Overview:

  • The Unconstrained mandate is a return to the firm’s founding principles, of a ‘go anywhere’ fixed income approach.
  • The strategy was launched in 1998 and has a compound annual growth rate of 11.5% since inception, and has made positive returns in each period of rising interest rates.
  • Despite it being a very different environment today versus the early 80s, the tools have not changed, namely:
    • Duration management
    • Curve management
    • Credit
    • Currency
  • While the approach is unconstrained, it is not a blackbox. The firm is vocal on their positioning with regular strategy updates as well as weekly, monthly and quarterly reporting that provides in depth analysis of the portfolio’s positioning
  • While investment approach is unique, they are purchasing traditional fixed income instruments, namely, treasuries, investment grade, high yield, mortgage backed and asset backed securities.
  • The use of derivatives is limited, and is used in the following ways. Reams believe that they use substantially less derivatives than their main competitors.
    • Duration management – it is much more efficient to manage duration through the treasury futures market, versus the cash market.
    • CDX/CDS – the strategy will often use high yield CDX to tactically invest in the high yield market. These CDX are always cash covered, and are used due to their low cost, broad diversification and liquidity.
    • Currency – forwards are used for currency hedging purposes.
  • The firm’s 4 managing directors, with input from the team, will make the broad strategy decisions on duration and exposures to credit and asset backed securities and cash.
  • The firm’s analysts transition their coverage every two years. With the goal of having a seasoned credit team that has covered the vast majority of the market.
  • This helps with relative value analysis, and also for analysts and PMs to be well versed in a market when it becomes attractive.

Investment Philosophy:

  • Fixed income investors are often lured in by the attractiveness of a bond’s yield.
  • A bond’s yield is the expectation/promise to pay if things remain static, ie. no change.
  • This year we have seen the US 10 year move about 120 bps. This is a typical year, with the 10 year having move over 100bps every year since 1981.
  • Reams is different, in that, instead of building a portfolio for yield, they look for total return. They try and utilize the inherent volatility in fixed income markets to generate superior returns.
  • To them, avoiding permanent loss or impairment capital is the most important thing. The volatility in bonds allows them to buy good quality bonds, when they are on sale, for whatever reason.
  • Unconstrained should not simply be a global search for yield, as that can add risk. Reams will not move down the capital structure or into emerging markets just to increase yield.  Like some unconstrained bond managers, they will not utilize equities and equity options to increase yield.
  • In short, Reams view volatility as an opportunity to participate in the markets. They view risk as the permanent loss of capital.

Current View:

  • Investors have been of the view that the Fed, ‘will always have their back.’ As such they have continued to seek out yield in all corners of the globe.
  • This behaviour, paired with the Fed’s intervention in markets, and QE in other markets, has led yields globally to continue lower, and spreads on corporate and high yield debt to continue to tighten
  • While a high yield fund must be 100% invested in high yield, and a bond fund tied to the broad fixed income indices will typically be similarly invested, Reams Unconstrained Mandate does not have a requirement to be invested.
  • The management team, being focused on avoiding the potential for permanent capital impairment are comfortable being largely in cash at the moment.
  • Fear and Greed coexisted in fixed income markets in 2014.
  • Volatility could present itself through ETF/mutual fund redemptions particularly in areas such as high yield, leveraged loans
  • The overarching view is that either treasuries are too expensive given the economic reality of the US (ie. yields need to go higher as the economy the economy is good/better) or that spreads need to widen (ie. credit needs to sell off as the economy is bad/worse.)
  • The fund is currently at -2.7 years of duration and an average maturity of 2.4 years. The fund has ~50% of the portfolio in cash.

Carlson

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