Canyon Value Up In January With Big Gains In RMBS


Canyon Capital Advisors, managers of the Canyon Value Realization Fund (Cayman), Ltd, recently released their January 2014 Commentary. This month’s newsletter, a copy of which was reviewed by ValueWalk, highlighted the outstanding performance of the Canyon Value Realization Fund (Cayman), Ltd during the month of January, the worst month for global stock markets in almost two years.

Canyon Value Realization Fund January performance

The Canyon Value Realization Fund (CVRF), Ltd turned in a stellar performance in January, tallying a .83% gain while the S&P 500 (INDEXSP:.INX) was down 3.46%. It should be noted that the Russell 2000 (INDEXRUSSELL:RUT) was also down 2.77% for the month, and the iShares MSCI Emerging Markets Indx (ETF) (NYSEARCA:EEM) was down a staggering 6.6%.

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January performance by asset class

According to the Canyon Value Realization Fund newsletter, corporate bonds contributed 15 basis points gross of the fund’s net return for the month. RMBS contributed 80 basis points gross, equities contributed 5 basis points, municipal bonds contributed 5 basis points, convertibles also contributed five basis points and corporate loans were a subtraction of 5 basis points gross. The newsletter also noted that the fund was a net seller of RMBS during January.

In the 2013 letter to investors, Mitch Julis of Canyon stated:

RMBS contributed 150 basis points gross to our returns in the fourth quarter and 735 basis points gross for 2013 (with a 25.1% gross return for the year).2 The alpha component of RMBS investing, which was not particularly visible in 2012 (when the whole Non-Agency sector rallied dramatically), became resoundingly apparent in 2013. In our 2012 year-end letter, we wrote the following about RMBS (comments with the benefit of hindsight are bracketed in italics):

“For 2013, we believe our RMBS positions can generate gross returns in the mid-teens or higher [we ended up generating gross returns of 25%].2 While the overall Non-Agency market should continue to benefit from a number of tailwinds, several sectors within this market are priced at levels where the risk/reward profile is unattractive [Prime securities in aggregate ended up generating less than 5% returns in 2013]. Therefore, credit selectivity has become more important, and we expect greater dispersion in performance this year within the Non-Agency space [a number of prominent mortgage investors struggled in 2013, and the Amherst Non-Agency RMBS Index was up only ~10% for the year].”

Selectivity will remain crucial as a determinant of RMBS returns going forward. In December, there was a $5 billion BWIC for Non-Agency RMBS (the Dutch government is in the process of selling its stake in the ING RMBS portfolio it assumed in 2009). There were 316 securities for sale – Canyon ended up bidding on only 50, and winning only 2 (purchasing $47M market value between these 2 line items). While we believe these purchases are poised to generate high returns, much of the list traded at high prices that would not appear to leave much margin for error with regard to assumptions.

While we anticipate continuing robust IRRs from our Non-Agency holdings, we expect to sell material portions of these assets over the next 6-18 months as they improve in credit quality and trade to lower yields. However, this phase of the RMBS story is by no means necessarily the “final chapter”. Uncertainty about central bank policy will likely continue to result in bouts of interest rate volatility that trigger disruptions in various parts of the RMBS market (as we saw from June-August). The most significant buyer of RMBS by far (the Federal Reserve) has only just begun to slow its purchases, and this process is unlikely to unfold seamlessly. At the same time, the future of the Agencies (Fannie Mae and Freddie Mac), which guarantee approximately 85% of outstanding mortgages, is an open question being debated by a polarized Congress. At some point, a combination of these variables could lead to significant dislocations in certain parts of the RMBS markets. Given Canyon’s breadth and long track record of success across the RMBS landscape (from both the long and short sides, across Agencies and Non-Agencies, pass-throughs and derivatives, and high quality and low quality pools), we are well-positioned to capitalize on any additional fractures across the mortgage space.

Canyon Value Realization Fund strategy

Canyon Value Realization Fund invests in a wide variety of asset classes, focusing on unrecognized value and taking advantage of market inefficiencies. The core investment strategy of CVRF is to find value and avoid volatility. “CVRF’s strategy is designed to generate substantially higher returns over time than equity indices with much lower volatility. Since 2009, CVRF has generated a 13% higher cumulative net return than the S&P 500 with less than half of the volatility (7.2% vs. 15.8%). Going back 10 years, CVRF has generated a 51% higher cumulative net return than the S&P 500 (145% vs. 94%) with less than 60% of the volatility (8.5% vs. 14.7%).”