Ellington Income Opportunities (EIO) suffered in the first quarter with strong headwinds from interest rate and credit spread volatility. Rates sold off throughout the quarter as the market priced in a more aggressive Fed hiking cycle. The yield curve bear-flattened with 2-year Treasury rates up 160 basis points (bps) while 10-year rates were up 82 bps. Credit indices also suffered as a result of the rate move in conjunction with the Russian invasion of Ukraine.
The fund’s interest rate hedging helped mitigate the impact of one of the most volatile rate environments in recent history.
Within residential assets, redemption-driven selling across various structured credit funds in March pushed residential mortgage-backed security spreads wider as supply weighed on the market. While spread widening was particularly acute in the fund’s single-family rental (SFR) assets, home price appreciation has allowed for significant delivering/cushion—for instance, the fund added an attractive 2020-vintage SFR asset with a current loan-to-value of approximately 67% versus 95% at issuance.
The commercial portfolio was relatively flat on the month with carry outpacing modest mark-to-market losses.
Corporate-backed investments saw mark-to-market losses outweigh carry. While not immune to price movement on a mark-to-market basis, we see these positions, much of which are de-levered mezzanine tranches, as very attractive from a risk-reward standpoint and especially versus their ratings.
In asset-backed investments, aircraft-backed securities detracted as the sector experienced a significant shock in the aftermath of Russia’s invasion of Ukraine. Russia ordered more than 500 western owned planes to remain in their country, many of which are owned by asset-backed security deals. While our Russia exposure was limited, the entire sector repriced significantly wider after many investors cut their exposure to the sector after experiencing significant losses. With some ABS securities trading 50+ points lower due to fundamental credit concerns, our holdings repriced wider in sympathy despite being unlikely to take losses.
The fund’s ability to weather credit and interest rate movements in the first quarter has placed it in an excellent position to benefit from current price dislocations across structured product markets. In many ways, this current market is one of the best trading environments for the fund’s assets since the volatility of 2020. Forced selling from certain poor performing funds has driven levels on structured credit assets, specifically RMBS, to very attractive spreads, especially when taking into account the previous 24 months of home price growth. Other larger fund complexes seem to have cash to deploy for these profiles, which should place a floor on prices. Such a market dynamic has created the potential for high trading gains for the fund, especially as the dealer community has shown limited appetite to position risk and capture bid-offer spread.
The fund also will look to diversify its RMBS holdings in the coming months, as other parts of the private label mortgage market now appear to offer compelling value. For example, the Credit Risk Transfer (CRT) market has experienced extreme widening in the first quarter on the heels of high supply. Certain parts of the CRT capital structure have widened several hundred basis points over the period despite consistent fundamentals. While there could continue to be spread volatility in the shorter term in these markets, we believe that they could produce significant long-term returns.
These materials have been provided for information purposes and reference only and are not intended to be, and must not be, taken as the basis for an investment decision. The contents hereof should not be construed as investment, legal, tax or other advice and you should consult your own advisers as to legal, business, tax and other matters related to the investments and business described herein.
The information in these materials does not constitute an offer to sell or the solicitation of an offer to purchase any securities from any entities described herein and may not be used or relied upon in evaluating the merits of investing therein. No such offer or solicitation will be made prior to the delivery of offering and related subscription or investment advisory materials (together, the “Offering or Advisory Materials”). Offers and sales will be made only pursuant to the Offering or Advisory Materials and in accordance with applicable securities laws. The information set forth herein does not purport to be complete and is qualified in its entirety by reference to the Offering or Advisory Materials. These materials are not a part of or supplemental to such definitive Offering or Advisory Materials. These materials will be superseded in its entirety by the Offering or Advisory Materials (and any supplements thereto).
The information contained herein has been compiled on a preliminary basis as of the dates indicated, and there is no obligation to update the information. The delivery of these materials will under no circumstances create any implication that the information herein has been updated or corrected as of any time subsequent to the date of publication or, as the case may be, the date as of which such information is stated. No representation or warranty, express or implied, is made as to the accuracy or completeness of the information contained herein, and nothing shall be relied upon as a promise or representation as to the future performance of the investments or business described herein.
Some of the information used in preparing these materials may have been obtained from or through public or third party sources. Ellington assumes no responsibility for independent verification of such information and has relied on such information being complete and accurate in all material respects. To the extent such information includes estimates or forecasts obtained from public or third party sources, we have assumed that such estimates and forecasts have been reasonably prepared. In addition, certain information used in preparing these materials may include cached or stored information generated and stored by Ellington’s systems at a prior date. In some cases, such information may differ from information that would result were the data re-generated on a subsequent date for the same as-of date. Included analyses may, consequently, differ from those that would be presented if no cached information was used or relied upon.
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AN INVESTMENT IN VEHICLES AND INSTRUMENTS OF THE KIND DESCRIBED HEREIN, INCLUDING INVESTMENT IN COMMODITY INTERESTS, IS SPECULATIVE AND INVOLVES SUBSTANTIAL RISKS, INCLUDING, WITHOUT LIMITATION, RISK OF LOSS. YOU SHOULD CAREFULLY REVIEW THE DISCUSSION OF RISK FACTORS IN THE RELEVANT OFFERING DOCUMENT, SUBSCRIPTION MATERIALS, OR MANAGEMENT AGREEMENT BEFORE DECIDING TO INVEST.
Example Analyses or Portfolios
Example analyses and portfolios included herein are for illustrative purposes only and are intended to illustrate Ellington’s analytic approach and approach to portfolio construction. They are not and should not be considered a recommendation to purchase or sell any security. The example analyses are only as of the date specified and do not reflect changes since that time. There is no assurance that Ellington will be able to secure investment in securities substantially like those discussed, construct a portfolio substantially like that discussed, or that the composition of any portfolio will resemble discussed examples at any future date.
Estimated P/L Attributions
P/L attributions discussed herein have been prepared in good faith by Ellington. These attributions, however, depend upon a number of assumptions, the use of Ellington’s models, and the application of judgment during preparation of the attributions. Moreover, the tools used to calculate these attributions may be refined over time, and not all data used to prepare these estimates may be available for all periods. The attributions shown may, consequently, differ from those that would be shown had a different methodology, including past methodologies, been employed or had different judgments or assumptions been made during their preparation. The methodology used herein for classifying P/L as “realized” or “unrealized” may differ from methodologies consistent with GAAP and the resulting attributions may, consequently, differ substantially from those that would result from methodologies consistent with GAAP. For these and other reasons, these attributions are of limited utility and are provided for informational purposes only. This attribution information should be read in the context of historical fund net performance provided to you separately.
Some of the statements in these materials constitute forward-looking statements. Forward-looking statements relate to expectations, beliefs, projections, estimates, future plans and strategies, anticipated events or trends and similar expressions concerning matters that are not historical facts. The forward-looking statements in these materials are subject to inherent qualifications and are based on a number of assumptions. The forward-looking statements in these materials involve risks and uncertainties, including statements as to: (i) general volatility of the securities markets in which we plan to trade; (ii) changes in strategy; (iii) availability, terms, and deployment of capital; (iv) availability of qualified personnel; (v) changes in interest rates, the debt securities markets or the general economy; (vi) increased rates of default and/or decreased recovery rates on our investments; (vii) increased prepayments of the mortgage and other loans underlying our mortgage-backed or other asset-backed securities; (viii) changes in governmental regulations, tax rates, and similar matters; (ix) changes in generally accepted accounting principles by standard-setting bodies; (x) availability of trading opportunities in mortgage-backed, asset-backed, and other securities, (xi) changes in the customer base for our business, (xii) changes in the competitive landscape within our industry and (xiii) the continued availability to the business of the Ellington resources described herein on reasonable terms.
The forward-looking statements are based on our beliefs, assumptions, and expectations, taking into account all information currently available to us. These beliefs, assumptions, and expectations can change as a result of many possible events or factors, not all of which are known to us or are within our control. If a change occurs, the performance of instruments and business discussed herein may vary materially from those expressed, anticipated or contemplated in our forward-looking statements.
Investors should consider the investment objectives, risks, charges and expenses carefully before investing. For a prospectus or summary prospectus with this and other information about the Fund, please call 1-855-862-6092 or visit our website at www.ellingtonincomefund.com. Read the prospectus or summary prospectus carefully before investing.
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