Hindsight 2020

2020 RECAP

Historical analogs for 2020 asset class (and fund) performance are virtually non-existent. The speed by which many asset classes and economic activity deteriorated in the second quarter of 2020 is unprecedented. Value-at-risk models, ours included, were woefully unprepared for such a shock. It is during such Black Swan events that asset managers must be nimble, level-headed, and remain steadfast to their process in the face of fear and uncertainty. And while this might sound like a simple investing tenet, in practice it is much more difficult. This was my number one thought as I repositioned the portfolio, quarantined in my dusty attic, during the dark financial days of March. Repositioning the portfolio in such a difficult environment is difficult – there is no perfect formula. An asset manager has to consider all of the following: 1) investors may redeem their investment by choice, or by necessity. 2) positions that you want to sell may have no underlying bid. And 3) panicked markets will often take the positions you have conviction in to levels you never thought possible. With these problems in mind, I had to make a few choices. First and foremost, I treated the sell-off as a generational buying opportunity in many of the bonds that we already owned. Specifically, the Business Development Company debt, with 3 to 5-year maturities, once yielding 5%, was suddenly trading at 20-50% yields, depending on the issuer. Second, I had to maintain enough cash for potential redemptions so as to not be a forced seller at fire sale prices. And third, many of the positions I no longer had conviction in, due to the Pandemic, were impossible to unload, given that there were no bids. So, I made a choice: I sold all of our TIPS positions and virtually all of our AAA CLO positions to fund potential redemptions and BDC debt purchases. At times, I was selling AAA paper at 7-10% yields so that I could take advantage of the sell-off in my favored asset class. I also chose to spend my time and energy pursuing this rebalancing rather than wasting time finding buyers of the debt I no longer had conviction in, and was likely to be permanently impaired – mostly in the energy sector. Indeed, we ultimately had four issues go to non-accrual and eventually file for bankruptcy. But this was a problem I addressed after the volatile market of March and April, and by buying quality bonds at distressed prices, I was able to more than make-up for these impairments. In our Q1 Newsletter, “Coronavirus – Market Fear & Opportunities Abound,” I wrote: “I do not know how bad it gets and how long the disruption lasts. Historically, pandemic fears have typically shaved 10-20% off of equity markets, but there is always tail-risk and human reaction and fear can certainly have a cascading domino effect when it comes to asset prices. That is the bad news. The good news is that there is a global initiative currently underway that will provide fiscal and monetary stimulus to a problem that could be temporary.” My approach to the portfolio has been driven by the statement above, and has remained consistent. After publishing the newsletter, the referenced “bad news” was certainly apropos. The S&P 500 ultimately plunged 33.8% from its February highs, and the Holbrook Income Fund (ticker: HOBIX) experienced a drawdown of 23.36% from its highs. At the time I wrote the newsletter, it was only down 1.47%. Again, this speaks to the tail-risk inherent during a Black Swan event. But more importantly, my belief that monetary and fiscal policy would provide a bridge to a more normal economy never wavered. As such, while volatility soared, and drawdowns reached levels unforeseen and unexpected, our process did not change, only the scorecard. I referenced this process in the Q1 newsletter:

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Disclosure: This article is distributed for informational purposes only and should not be considered investment advice or a recommendation of any particular security, strategy or investment product. ...

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