Structured finance may not always be an easy feat to tackle for pension funds, endowments and foundations and Taft-Hartley plans, but if you mix one part sophistication with one part Putnam Investments' Structured Opportunities strategy, you'll find the reward is well worth the risk, said Rob Bloemker, managing director, portfolio manager and team leader for the Boston-based firm's core fixed-income team's mortgage- and asset-backed securities and government group.
"We typically have greater luck discussing this with more sophisticated investors," he said. "We realize that to most people this sounds very complex, but with the experience that we have with many of our team members having been in this market since the inception of these securities, we feel very comfortable with such complexity. In fact, it seems to be the norm for us.
"We find that sophisticated plan sponsors are looking for uncorrelated excess returns. That is both uncorrelated to general market moves, including the large macro themes of duration and credit, and also uncorrelated to other managers and other excess returns that they may have in their portfolio. Our returns in this product have shown virtually no correlation to any market. Since it's such a unique sector and our process is unique within that sector, there is very little correlation to other managers as well."
Bloemker said that the strategy also tends to be risk adverse and can usually hold up against market turbulence.
"Unlike many other strategies that you may run into, our strategies typically work best in times of stress," he explained. "We find that in a stressful environment, participants in our market tend to act less rationally allowing for security inflection opportunities to be found."
Spectrum of Opportunities
Bloemker said that the returns seen in Putnam's Structured Opportunities strategy are rather generous. For instance, investments in the general MBS sector generate 50 basis points of excess returns.
"As you get into IO/PO (Interest Only/Principle Only), we think 200 basis points," he said, referring to the spectrum of investment opportunities pictured in the chart. "From the left side of that spectrum, starting from 0 and going left, you get a little more credit risk. We think in the agency and triple-A sector that we can generate about 50 basis points. When you get down to single-A, we can generate 200 basis points and below investment grade can generate 500 basis points. Putnam's Structured Opportunities seeks opportunities across this full spectrum, utilizing all available combinations of sector (MBS, ABS, CMBS) and structure (IO/PO, Inverse, etc.) regardless of rating so that we're as diversified as possible."
The firm decided to create the strategy for its institutional clients who were looking to take on greater risk and earn higher returns outside of equity, high yield and emerging markets, said Bloemker.
"They came to us and what we discussed with them is that our 50 basis points is a better risk than those investments," he explained. "Those other markets might give you 2%, 4% or 10%. We came up with an institutional offering called Structured Opportunities, which is an effort to leverage our alpha source the - 50 basis points - into a 10% portfolio, utilizing all of our opportunities across that spectrum and our specialist nature. We're really employing the same strategies that are being used to outperform benchmarks across all of our different mandates, but in a fashion that would generate outright returns and our target was 10% over Libor."
The strategy, which is approaching its five-year anniversary, has $350 million in institutional assets under management and has average returns of 10% over Libor.
Ten years ago, the firm transitioned from the typical portfolio manager, analyst and trader structure to a team specialist approach. Bloemker explained that Putnam selected this approach because it felt that the markets were becoming increasingly complex and that the "old-fashioned" version of a portfolio manager was too general to compete in this modern and complex world.
"A generalist would focus more on top-down strategies where those were getting more difficult to be consistently profitable and it was better to have a bottom-up approach," he said, adding that the mortgage team was developed first.
"We started out managing mortgages against the mortgage index and also against the mortgage portion of the aggregate index," Bloemker said. "We then realized it was fairly easy to take the amount of money that we were making and move that to LIBOR. We would use our mortgage investment process against institutional and retail mandates for both mutual funds and separately managed accounts, with multiple guidelines whether it was to be a government index, an aggregate index or a mortgage index. When we looked at the mortgage market we felt there were two primary risks that we could capitalize on, and anytime there is risk, there is opportunity."
Bloemker said the first risk considered was prepayments, which is the risk that you get your money back sooner or later than anticipated, due to the refinancing of the homeowner. The second risk was structured credit risk.
"The majority of mortgages are guaranteed either by the government through Ginnie Mae or through agencies Fannie Mae and Freddie Mac," he explained. "But, there are non-agency securities and in the last few years, this market has grown tremendously. That's typically the asset-backed securities market and the commercial mortgage-backed securities market."
Bloemker added that these two risks are very different, but that Putnam wanted to play on both sides of the market-prepayment risk and structured credit risk-because it felt that both offered opportunities.
"We think that this is a very unique market," he said. "We've been involved in these securities and this sector for the last 20 years. We don't run into many other competing products that offer something as unique as this specialized sector." - Jakema Lewis
Rob Bloemker is a managing director and team leader of the Mortgage-backed Securities/Asset-backed Securities/ Government group on the Core Fixed-Income team. He joined Putnam Investments in 1999, and serves on the firm's Advisory Council and Executive Committee. He has a B.S. and a B.A. from Washington University.
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