Research

There has been a significant ongoing litigation that involves several trusts that were organized by JP Morgan. This litigation is at its end-stage, and, at this point, there are minor court rulings coming out. The court rulings involve the timing as well as the amount of the settlement that needs to be paid out to each trust by JP Morgan. ESM is constantly looking at these bonds when they are offered into the market.

The asset management industry is dominated by a buy-hold-hope mentality, which makes sense in most cases because, statistically, the equity markets go higher 80% of the time. We are taught that to achieve great long-term returns, we must be willing to ride through periods of high volatility and that corrections happen along the way. Considering that the long-term average peak-to-trough drawdown in the S&P 500 is 14%, I believe that most financial advisors and clients would agree that a smoother ride would be the preferred way. Strong returns with lower volatility along the way sounds a lot like having your cake and eating it too. What if this might be possible?

Many bond portfolios consist of investments that replicate the Bloomberg Barclays U.S. Aggregate Bond Index (the “Agg”), which does not include about two-thirds of the investable fixed income space. These bond portfolios leave many investors under-exposed to the broader fixed income universe and with concentrated risk exposure to rising interest rates.

Most MBS securitizations contain a call right that is vested with the servicer of the bonds. Imagine a pool of 4,000 30-year mortgages. By the time year 29 comes around, there may be less than 50 mortgages remaining. So the servicer is not stuck collecting from 50 mortgagees and applying those payments to various bonds, the call right allows the servicer to call the outstanding bonds and possibly re-securitize the remaining mortgages with other mortgages from other trusts that may have also been called. Typically, these call rights trigger when there is less than 5% to 10% of the original principal value of the trust remaining.