A structured finance investor talks the big 2023 themes

Karlis Ulmanis is a portfolio manager at DuPont Capital in Delaware, which has total AUM of $20.1bn. The core fixed income portfolio is worth $1.3bn, and Karlis manages the $550m securitized debt section comprised of CMBS and RMBS. He manages these assets against structured products sub-index of the Bloomberg USA Bond Index.

This week SCI asked him where he sees value at the moment.

Q: Nice to talk again Karlis. What are the dominant features of your areas of the market at the start of this new year?

A: Interest rate risk hangs over everything. This has changed everything. Last year we started with overnight rates around 0.25% and they’re now between 4% and 5%. That is a big difference. And we don’t know where things go from here. Every time there is a good print or a bad print in CPI, PPI or retail sales, the market reacts. Volatility has greatly increased and I’m trying to get through it.

Q: What impact does this have in RMBS?

A: Well, in addition to the obvious interest rate risk, there is much less loan turnover. Refinancings are down to levels we haven’t seen since 1996. This affects prepayment speeds. So, for example, there are heavily discounted Fannie Mae 1.5% mortgage TBAs which are trading at 80 cents on the dollar, but you need to factor in when you might get paid back. So I’m very wary of deep discount bonds as prepayments are so slow. Going from 2% mortgages to 6.5% mortgages adds about $350 per month per $100,000 borrowed to a borrower’s mortgage payment, so no-one wants to do that.

Q: How have you responded?

A: I don’t think there is much value in shifting around. I am doing very little trading at the moment. There is nothing that really jumps out at me. I’m just waiting for paydowns and then invest that. I was underweight the lower coupons, but now am flat.

Q: You were focused on pockets of value in CMBS last year. How has this changed?

A: Like RMBS, interest rate risk is the dominant feature. It is much more difficult for CRE loans to be refinanced so existing loans tend to be modified or extended. I did buy short duration CMBS conduit bonds last year, which overall have done well but they’re not paying out as soon as I would like, which would allow me to reinvest at a higher rate and realise yield. It’s the same dynamic as in RMBS.

Q: Tell us a bit more about the short duration CMBS bonds you own?

A: I’m happy with them as they are high quality in terms of collateral. They have low LTV, high debt service coverage ratio and generally high occupancy. They have performed well from that standpoint but I’m just not getting the money back as soon as I would like.

Q: What areas of the CMBS market look better, or worse, than others?

A: All last year I was focused on the retail space as it looked undervalued. But there are problems with refinancing this year, as I’ve alluded to. As long as a bond has good credit support I’m not too worried, but you have to be careful of not stepping into a hole and buying a mall that doesn’t look good at all.

This year I’d be wary of the office building space. There’s negative risk here as people aren’t coming back to work. That needs to change, or the supply needs to adjust downwards, for this to look better, or both.

Q: So it’s a bit of a hold and wait strategy at the beginning of this year then?

A: I’m afraid so. I’m just not seeing anything terribly exciting at the moment!

Simon Boughey