Market Commentary Q3 2021

November 30, 2021 Market Commentary


The early months of the third quarter were characterized by slower trading volumes after nearly 18 months of frenzied activity post-March 2020. However, trading activity picked up as summer came to a close and volatility returned to the markets. The yield on the 10-year U.S. Treasury note closed nearly 18 basis points (bps) higher month-over-month in September, high yield corporate credit spreads widened approximately 25 bps, and the S&P 500 was down 4.8%. Despite these market moves, the Fund posted a strong month to close out the quarter as structured product spreads remained relatively stable and the Fund’s low duration positioning provided shelter from the rate selloff. 

Market Environment 

Within residential assets, fundamental performance in US residential mortgage-backed securities (RMBS) continues to be a tailwind for Fund returns. The combination of strong home price appreciation, declining delinquencies from COVID-19 payment deferral programs, and faster prepayment speeds have all served to benefit realized returns from pre-crisis RMBS. 

Commercial Real Estate (CRE) CLOs have shown continued price resiliency despite an unusually heavy new issuance pipeline. 

Within the corporate space, strength in the leveraged loan market has been helpful for the Fund’s collateralized loan obligation (CLO) holdings. Trailing 12-month leveraged loan default rates remained low at just 0.47% with only 4.7% of the market currently trading below a 95 dollar price. While a healthy loan market has benefitted the fundamentals of our CLOs, high new issuance volumes in US CLOs weighed slightly on spreads this quarter, particularly at the top of the capital structure. Many CLO managers appeared to be rushing to issue and refinance deals before year end, when the transition away from Libor is expected to occur, in order to avoid any temporary disruptions that may occur as a result of the change. 

In asset-backed investments, senior aircraft-backed securities contributed marginally as they were held back on COVID delta variant-related news. We will continue to monetize aircraft EETC seniors as they tighten. Mortgage REIT preferred equity was driven by carry as more general performance in the space was mixed on the quarter. 

Fund Outlook 

Despite broader market volatility, structured product spreads remained remarkably flat through quarter-end. As we head into the year’s final quarter, there are looming macroeconomic issues on the horizon, such as the potential breach of the US debt ceiling, which could generate significant market volatility. This potential for volatility could coincide with year-end, when balance sheet constraints typically drive forced selling from dealers and accounts, potentially leading to attractive entry points for the Fund. We see the Fund as positioned with a number of higher-quality assets that should not only prove defensive on a relative basis in a market pullback, but which could also be sold and replaced with more distressed assets should such a move occur.

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. 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. 


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. 

For Carry Assets / Distressed Resolution Strategies: 

Unlevered Carry: This represents the model-based, loss-adjusted yield of the relevant assets before giving effect to leverage. This includes, without limitation, the effects of interest income and return of principal for assets at a premium or discount to par, as well as amortization of the premium or discount to par. The figure does not necessarily represent current period cashflow of the assets. For example, a zero coupon Treasury bill would contribute based on its yield to maturity despite making no interest or principal payments before maturity. The figure does not include any assumption of total return due to trading the relevant assets. 

Unlevered Resolution Run Rate: This applies to strategies that generally do not derive the majority of their income from regularly scheduled payments but where the assets are purchased at a discount to fair value due to non-performance or reperformance of the credit. The Unlevered Resolution Run Rate represents the model-based rate of discount capture expressed as a percentage of dollar investment amount for the resolution of the asset. For example, for a non-performing residential mortgage loan, this would represent the modeled rate of return on assets invested from foreclosure sales, short sales, discounted pay-offs, and similar asset resolutions; this figure would not, however, include any assumption of total return due to trading the loans themselves. 

Net Run Rate = Unlevered Carry + Unlevered Resolution Run Rate + Financing Cost (all represented as a percentage of investment amount) 

Levered Run Rate (% Capital) = Net Run Rate x (Investment Amount / Capital Deployed) 

Levered Run Rate (% NAV) = Net Run Rate x (Investment Amount / Fund NAV) 

For Relative Value Strategies: 

Run Rate (% Capital): Represents an expected rate of return based on historical performance for strategies for which relevant historical information is available or in other cases based on backtest or models. Performance is based on deployed risk capital. In contrast to Carry Assets / Distressed Resolution Strategies, this includes assumptions about total return due to mark-to-market and trading of the relevant instruments. 

Run Rate (% NAV) = Run Rate as % of Capital x (Capital Deployed / Fund NAV) 

For Shorts: 

Short Notional Equivalents: Amount of credit hedges expressed in on-the-run HY CDX equivalent notional computed using model-based hedge ratios for each hedging instrument. 

Run Rate (% Notional Equivalents): This figure represents the model-based, loss-adjusted hedging cost, including the effect of ongoing interest expense, expected credit losses, and amortization of the premium or discount to par. The figure does not include any assumption of spread widening or tightening (such as the effect of spread roll-down).