Introduction
Ellington Income Opportunities (EIO) generated negative performance in the second quarter with extreme volatility across capital markets. From interest rates to credit, a large repricing of risk has occurred across markets as the prospect of a less supportive Federal Reserve and potential for a recessionary environment quickly shifted market attitudes towards defensive posture. Intra-quarter, the S&P was down over 16%, investment grade corporate spreads widened 34 basis points (bps), high yield spreads widened 203 bps, and the 10-year Treasury note sold off 68 bps.
Market Environment
Within residential assets, the fund’s focus on seasoned residential assets has helped to minimize return volatility as these assets have traded with a much lower beta to general credit spreads.
The fund’s commercial holdings saw mark-to-market losses in Q2. Widening in the commercial sector was particularly acute at the top of the capital structure, and securities in this sector now trade to substantially wider spreads despite stable credit profiles. Within the commercial sector, we continue to focus on deals backed by multifamily residential properties.
Corporate-backed investments were the most significant detractor on the quarter, with collateralized loan obligation (CLO) exposure driving those mark-to-market-driven losses. After outperforming for much of 2022, CLOs weakened further in June after capitulating in May.
In asset-backed investments, aircraft-backed securities detracted. These positions were already trading at distressed levels from events in Ukraine/Russia and have not moved significantly since. The fund entered into a supply chain financing arrangement, adding a new satellite strategy which should provide strong risk-adjusted returns.
The fund’s interest rate hedges contributed to the fund’s total return in Q2. Although the fund invests in many floating rate assets, interest rate hedges were in place to protect against the duration of the fixed rate components of the portfolio.
Fund Outlook
Having reached the second half of 2022, it is notable in retrospect how quickly market narratives flipped from a “reach for yield” to one of more defensive positioning. In our view, the current market is one of the most attractive entry points for structured products in quite some time. Assets with little to no credit risk, even in the face of harsh economic shocks, now trade at some of the widest levels in product history. However, the current trading environment is extremely challenging as spreads have steadily widened this year without a clear catalyst for reversal. Although spread volatility may persist, the carry profile on the fund’s assets have improved as well, creating a strong entry point with significant upside.
Important Notes
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.
By acceptance hereof, you agree that (i) the information contained herein may not be used, reproduced or distributed to others, in whole or in part, for any other purpose except as expressly provided herein without the prior written consent of Ellington Management Group, L.L.C., Ellington Global Asset Management, LLC, or its affiliated advisers (together, “Ellington”); (ii) the information contains highly confidential and proprietary ‘trade secrets’; (iii) you will keep confidential all information contained herein not already in the public domain; and (iv) you will not use such information for any other purpose, including trading in the securities of other Ellington entities.
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.
Forward-Looking Statements
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.
Distributor – Foreside Fund Services, LLC