In my original article suggesting the AlphaCentric Income Opportunities Fund (IOFAX or IOFIX) I provided a chart comparing it to the Barclays Aggregate Bond Index.
But for a real test, how has this bond fund performed versus the Standard and Poor’s 500 Index since its inception three years ago?
Better...
Source: Fidelity / Author
That’s right – the S&P (the sort-of-chartreuse line) has roared ahead 37.3% over the past three years. A fine return…
However, over this same time frame, IOFIX has returned 39.2% and IOFAX has returned 38.3%.
Lest anyone think “Yes, but the S&P was down 68 points on Thursday" this chart reflects only full-month numbers – through February 2018. March will actually show a more positive disparity.)
IOFAX is the AlphaCentric Income Opportunities Fund “load fund” class. I buy it for clients because, as clients of a Registered Investment Advisor, clients pay no load and no transaction fee. But there is also an Investor Class (IOFIX) that has performed incrementally better over the three years this fund has been in existence. (By the way, the managers of IOFIX / IOFAX have been doing exactly what they do for their mutual fund for quite awhile before they started the fund, managing SMAs -- Separate Managed Accounts -- for institutions and wealthy individuals.) For brevity, I’ll just use IOFAX when discussing the fund.
Now, if a bond fund can out-perform the S&P 500, it must be as risky as stocks, right? No.
There are “niches” in the bond world that can provide out-sized returns. I won’t repeat my entire “Harry the railroad bond client” from my original IOFAX article, but I strongly suggest you read that story. Search: IOFAX Shaefer. That true account of the brilliance of an early client of mine is the perfect illustration of how “some” bonds at “some” times can return many times what more common investments can provide. Harry, the 80-year-old retired bankruptcy judge, found his niche and made a fortune.
Harry’s investment in bankrupt railroad bonds, and my choices of these three safer havens from the travails I expect from the stock market this year, are of course not without some risk.
So herewith all the boilerplate I can find canvassing these three funds' websites, from which I have rewritten the risk factors into something approaching English rather than SEC-ese:
All investing involves risks of fluctuating prices and the uncertainties of rates of return and yield inherent in investing.
To the extent these funds in mortgage-related securities, their exposure to prepayment and extension risks may be greater than investments in other fixed-income securities.
These funds all reserve the right to use derivatives, such as options and futures, which can be illiquid, may disproportionately increase losses and have a potentially large impact on their performance.
High-yield securities, or “junk bonds”, are rated lower than investment-grade bonds because there is a greater possibility that the issuer may be unable to make interest and principal payments on those securities.
Foreign investing may have other risks including currency fluctuation and economic and political risks not found in investments that are purely US-based.
I have reviewed all these risks and am willing to make these three funds the cornerstones of my triangular investing pyramid. I’ve already made the case for IOFAX, it is the largest component of our just rebalanced Investor’s Edge ® model portfolio, and my largest single holding for my family portfolios, so I’ll direct my attention to the other two.
Make no mistake, IOFAX is my favorite. They pay monthly, their current yield is 4.7% and I fully expect to see continued capital gains from the insightful positioning AlphaCentric’s management team employs. But that very skill-set does make them potentially more risky than the other two.
Be advised that AlphaCentric, as the newest of the three, has a higher expense ratio. But we must remember that the actual dollar expenses may be the same for a fund with $500 million in Assets Under Management and one with $1 billion in AUM, but “as a percent” the smaller fund will reflect expenses that are twice as high.
My belief is that IOFAX will grow rapidly as a result of their stellar performance. As that happens, the percent they charge will drop of course.
While IOFAX is my first choice, my next two choices are no mere nags, either. They may not win the Derby but I believe their journeyman consistent performance will reward their owners well.
I pick the Voya Securitized Credit Fund (VCFAX and other classes) to Show and the Semper MBS Total Return Fund Investor Shares (SEMPX and other classes) to Place. With three-year returns of, respectively, of 13.5% and 15.6% -- for bond funds, mind you – these are genuine thoroughbreds as well.
Voya Securitized Credit also reviews the three primary areas of residential mortgage obligations (securitized residential credit, non-qualified mortgage loans, and re-performing mortgage loans.) They select a different (and the rating agencies would likely say a less risky) mix than AlphaCentric does.
Under normal market conditions, the fund invests at least 80% of its net assets (plus borrowings for investment purposes) in various types of securitized credit securities. VCFAX et al cast their net a little wider: their securitized credit holdings include commercial mortgage-backed securities ("CMBS"), asset-backed securities ("ABS"), agency and non-agency residential mortgage-backed securities ("RMBS"), and collateralized mortgage obligations ("CMOs") but the investment case is the same.
VCFAX and all the other classes of Voya Securitized Credit pay monthly; the annualized dividend is 4.06%.
Bear in mind, of course, that in all three cases, these are merely the dividend rates. They do not account for the possible capital gains that will accrue if mortgages are paid off early, as buyers modify their debt payments, through trading of the securities in the portfolio, etc.
The investment case is the same for the Semper MBS Total Return Fund (SEMPX.) This fund also invests 80% of its assets in non-agency mortgage-backed securities. The weighted average maturity of the fund's MBS (mortgage-backed securities) investments is roughly between 1 and 10 years. The fund may invest without limit in MBS that are rated below investment grade.
Just four and a half years old, Semper MBS has already surpassed the $1 billion in assets under management mark. As has been the case with Voya and AlphaCentric, the strengthening in real estate credit fundamentals, excellent home price appreciation, and good but not overheated new and existing home sales have all contributed to the investment case. It doesn’t hurt that average disposable income is also rising.
SEMPX pays monthly. The dividend yield is 5.1%.
The essence of my respect for the business these three funds are in is, at its most basic, the fact that the collateral (home values) supporting the underlying assets (homes) is rising. What may once have been a dicey loan-to-value proposition is now mainstream.
If you believe that is all over because rates will rise 1%, none of these three may be for you. At 1% higher mortgage rates, we are still under the average of the past forty years so I see this as an overlooked opportunity, and one where the volatility is decreasing daily.
This is a $500 billion market but is too fragmented for the big Wall Street banks to dominate. In fact, they don’t want the SEC or the public to associate them with this marketplace since they are the ones who destroyed it just 10 years ago. Today, however, these are like Phoenix rising from the ashes caused by the big banks’ greed. Whenever I can find a niche market big enough for liquidity but too small to be trampled by Wall Street, I’m all for it!
If you are wary of putting all your eggs into the equity basket of common stocks, consider these three real estate mortgage (and other securitized credit) mutual funds. They all pay steady dividends, they all pay them monthly, and on Thursday 22 March, with the Dow down 724 points, here are the amounts each of these three fell:
IOFAX: unchanged
SEMPX: unchanged
VCFAX: up 1 cent per share
Good investing,
JS
I and our clients own IOFAX, SEMPX, and VCFAX
