For years, conventional fixed income struggled to pay rates. But Manning Asset Management continues to beat the crowd – Written by Hans Lee, Livewire Markets.

 

The story of fixed-income underperformance has been well-telegraphed. But look beneath the surface of the government bond market and you’ll find that alternative sources of fixed income have fared much better. Some of these outperforming assets include consumer loans, business loans, and in particular, the mortgage-backed asset market.

Mortgage-backed assets are, and we hasten to point this out, are not the same things as the kind of mortgage-backed securities that brought down Lehman Brothers and the like in 2008.

The Manning Monthly Income Fund could have invested in traditional, publicly traded RMBSs but they chose not to because they knew there was a better way to access the market. This presented a quandary for Josh Manning, founder of Manning Asset Management and his team.

How can you capture reliable income in the wider property space without (literally) betting the house?

To get around this problem, the Fund has taken a big interest in carefully chosen, high-quality mortgage-backed assets. Today, mortgage-backed assets actually make up more than 50% of the Manning Monthly Income Fund and are a big source for its long-term outperformance.

In this wire, I’ll share some insights into how the team invests in this traditionally opaque and challenging part of the market.

Outperforming the benchmark (and the plan to stay ahead)

According to the Livewire funds database, the Manning Monthly Income Fund has been the top performer over the last three years in the fixed income category. Since its inception, it’s returned 6.53% per annum to shareholders. So how did it do it?

“It’s really about finding the right strategy which can perform through different market conditions,” Manning said. “We’re not really looking to outperform.”

But the statistics don’t lie – and the fund really has outperformed its competition. Manning attributes the fund’s stability to three things:

1. Finding a strategy that is designed to stand the test of time.
2. The right people in the right seats at the decision-making table – including finding people with vast amounts of market experience.
3. Get the incentives right – and this extends from business structure to the general investment philosophy

“For seven years, through all sorts of geopolitical issues, through all sorts of RBA cash rate profiles, through all sorts of macro backdrops, we have just consistently hit our RBA + 5 objective. It’s not about trying to go over, it’s just about consistency,” he added.

The fund has a target return of the RBA cash rate plus 5%. With the cash rate now over 4%, how does Manning plan to stay ahead?

“I think you have to be really careful about where you’re playing,” he said. “We really like that shorter-dated, shorter-weighted average lifetime fixed income investments which don’t have that long duration aspect.”

The shorter-dated end of the market, Manning explains, doesn’t expose investors to as much credit spread risk. Note that “shorter-dated” in this context means anything that matures in under 24 months (and in a lot of cases, under 12 months).

“We also like stuff where we think the asset class, its structures, and its counterparties can perform through the economic cycle. If you can get that right balance, the asset class provides strong returns, asset diversification, strong and consistent income, low volatility, and capital stability,” he emphasised. “But you have to be very deliberate.”

The assets in the fund

The old adage argues that “diversification is the only free lunch in investing”. But Manning and his team take that to a whole new level. The Manning Monthly Income Fund has over 10,000 individual asset exposures. But who is backing these assets?

“We’re looking across the market – literally hundreds of lenders – and trying to find lenders that we believe are the best in their field and can offer very attractive pools of loans that we can purchase,” he said.

To explain this point further, he referenced a recent deal the team were involved in.

“We negotiated for 135 basis points more yield. We’re also saying we want more capital protections and not only that, we want to enhance liquidity. We want better terms than those being offered to the market,” he noted. “Because this is all we do, we can be very active and we do pull back.”

All of which, Manning says, is backed by what they call “proven counterparties”. But what makes a proven counterparty?

“Essentially, we don’t rely on credit ratings and third-party research. We have deep relationships and a long track record of working in this sector,” he said.

He added that the team may receive five to six deals on average per week, but the investment management team may only execute one or two of them per month.

“We have a proprietary process where there is a formal, invasive process to go under the hood of lenders. It includes things like on-site visits and meeting with key and junior management. I call it a contact sport,” he quipped. “There is a very clear alignment of interests.”

The property aspect

As has already been noted, more than half of the fund’s composition is dedicated to residential and commercial MBSs. Those positions have only continued to rise, especially in the residential space where allocations to that part of the market are near all-time highs.

So what does Manning think about the future trajectory of the property market? He says that property needs to be evaluated in a much more granular way. Each segment, area, and asset need to be assessed individually to understand the fundamental and risk profile of each potential investment.

“The Australian property market is quite an academic principle,” he said. “You don’t have to be a property market forecaster. We’re not trying to say property will be up or down a certain amount. Our focus is on the risk profile,” he added.

“The question is not whether property will be up or down by a certain percent in 12 months’ time. The question is, how safe is our capital and do we strongly believe we will receive 100% of our principal back at loan maturity. To answer that, you need a fundamental understanding of each segment of the market to gauge risks and pockets of value,” he added.

As a result of his views, Manning points out that the fund does not play in conventional methods – or indeed, the kinds of securities that were so much the subject of the 2008 Financial Crisis.

“We’re not in traditional RMBS or CMBS-type securities. Those are public deals that are highly structured and to get a good yield, you have to be heavily subordinated. To do that, you take on more credit risk and more mark-to-market risk,” he said.

“What we prefer to do is to go directly to these issuers and structure deals directly with them. We’re purchasing actual loans themselves. We’re not buying off an exchange,” he added.