Keeping an Eye Towards the Future During a Crisis

Few things will test an investor's mettle like a sharp market dislocation. What matters then is how well an investor remains focused and disciplined. 2020 served as one of those years that reminds us of the importance of a disciplined process—and keeping an eye on the future.

When the COVID-19 crisis hit, we knew forced shutdowns would immediately produce high unemployment. While we knew it would be hard on consumers, as investors, there was nothing to be done about the inevitable—so our focus shifted to what the recovery could look like.

Bonds don't immediately default, and our risk management process involves using 2008 as our base case in underwriting to stress test the bonds in our portfolio. Using the worst financial crisis since the Great Depression, we know the approximate level of stress our bonds can take and what the break points are—it's about loss multiples a bond can withstand before the first dollar of principal loss. Our analysis for some of the higher-rated bonds in the portfolio showed they could take multiples, sometimes well over five times the stress of 2008. The lower-rated bonds may be able to handle one times or more. With this perspective, we looked past the noise in early 2020 knowing the market was likely overreacting—amplified by forced selling into a liquidity vacuum—particularly when it came to the more supported bonds.

Additionally, every month securitized products release a remittance report, detailing collection and loss data—we knew we'd soon see how consumers were faring in repaying short-term debt. Then we saw the stimulus packages that were coming, which added to our conviction that the market had overreacted, and we were right to focus on the longer term.

It's also important to compare consumer health in general versus the bonds we hold. The issuers we talk to don't just issue a loan to anyone. They each have their own methods, analytics and criteria. Our job is to compare issuers and their underwriting—we want to invest with issuers who are skilled at managing their own risk so our bonds can outperform the macro environment. By doing so, we believe it provides keen insight into issuers and their securities.

A key point to consider based on what we saw in March and April 2020: We hope that was an unusual event—a once in a century event—but we recognize our strategy has a different liquidity profile than most short duration strategies, which is intentional—we believe the opportunities for yield justify the tradeoff.