Introduction
Ellington Income Opportunities (EIO) achieved a net performance of +1.88% in the fourth quarter1. Credit assets rallied as central banks cut interest rates and economic growth expectations accelerated. U.S. rates bear steepened after the election, and the 10-year Treasury sold off 89 bps intra-quarter. Structured product spreads benefitted from this risk-on environment, tightening in line with corporates despite heavy quarterly supply across CLOs, CMBS, and RMBS. For the fourth quarter, spreads on legacy RMBS tightened 35 bps, non-QM AAAs 10 bps, SFR AAAs 10 bps, and US CLO AAAs 10 bps.
Market Environment
The fund’s CRT exposure continued to benefit from strong fundamental performance and net negative supply. Freddie Mac offered to repurchase seasoned first-loss CRT bonds in October. This tender offer was the first time any GSE has successfully repurchased first-loss risk from the market. Spreads on seasoned below-IG risk moved tighter as investors processed this market event.
CLO spreads benefited from retail interest at the top of the capital stack. Total CLO ETF assets under management grew by approximately 40% in Q4, or over $6 billion inflows, focused on high-grade CLOs. One of the fund’s CLO positions held at a modest premium was called in December. High turnover in CLOs driven by heavy refinancing activity has reduced potential for price appreciation for much of the space. Despite this, carry profiles found in deleveraged CLOs continue to deliver compelling returns for the fund.
Commercial spreads moved tighter this quarter as perceived relative value versus corporates drove demand for IG securities. While the challenges of higher interest rates and rising delinquencies remain, investors have been optimistic that an uptick in transaction activity will bring greater price transparency for underlying collateral, and that new originations appear to be structured attractively for investors.
Aircraft ABS continued to benefit from strong fundamental performance in Q4 as underlying collateral values were aided by weak manufacturing volume and steady growth of consumer demand for flights. The fund’s holdings have also de-levered and de-risked, with many BB tranches beginning to distribute cashflows after accruing distributions for the last few years. Despite a recovery in bond prices, our holdings continue to offer attractive risk adjusted returns.
Fund Outlook
As we move into 2025, we are maintaining a focus on sourcing fundamentally resilient carry assets for the fund. Given the outperformance of credit products this year, it is less likely that forward returns will benefit from substantial price appreciation due to spread tightening. Instead, we are focusing on securities with defensive characteristics, such as shorter average life, seasoning, or deleveraged structure. We believe these bonds will provide strong returns in a benign environment and protect the fund’s capital base in a drawdown.
Important Risk Disclosures
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.
Definitions:
CMBS: (Commercial Mortgage-Backed Securities): Bonds backed by a pool of commercial real estate loans, providing investors with exposure to income from property assets like office buildings and shopping centers.
RMBS: (Residential Mortgage-Backed Securities): Bonds backed by residential mortgage loans, offering returns derived from homeowners’ mortgage payments.
Non-QM: (Non-Qualified Mortgage): Home loans that don’t meet the strict criteria of qualified mortgages, often catering to borrowers with nontraditional income or credit profiles.
BPS: (Basis Points): A unit of measure equal to 1/100th of a percent, commonly used to describe changes in interest rates or financial metrics.
CLO (Collateralized Loan Obligation): A type of structured security backed by a pool of corporate loans, typically leveraged loans made to businesses.
CRT: (Credit Risk Transfer): Financial instruments through which mortgage guarantors, like Fannie Mae or Freddie Mac, transfer mortgage credit risk to private investors.
Deleveraged: The reduction of debt or financial leverage, often to lower risk or meet regulatory requirements.
CDXHY: (Credit Default Swap High Yield Index): A benchmark index tracking credit default swaps on a basket of high-yield corporate bonds.
ABS: (Asset-Backed Securities): Bonds or notes backed by financial assets like auto loans, credit card receivables, or student loans, providing cash flows to investors.
De-lever: The process of reducing leverage, typically by selling assets, paying down debt, or increasing equity to improve financial stability.
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 carefully consider the investment objectives, risks, charges and expenses of the Ellington Income Opportunities Fund. This and other important information about the Fund are contained in the Prospectus, which can be obtained by contacting your financial advisor, or by calling 1-855-862-6092. The Prospectus should be read carefully before investing.
Investing involves risk including the possible loss of principal and including the following: Market Commentary | Q3 2023 3
• Shares of the Fund will not be listed on any securities exchange, which makes them inherently illiquid.
• There is no secondary market for the Fund’s shares, and it is not anticipated that a secondary market will develop.
• The shares of the Fund are not redeemable.
• Although the Fund currently intends to offer a quarterly repurchase offer, the Fund is not required to repurchase shares at a shareholder’s option nor will shares be exchangeable for units, interests or shares of any security.
• Regardless of how the Fund performs, an investor may not be able to sell or otherwise liquidate their shares whenever such investor would prefer at the time or amount desired.
An investment in the Fund’s shares is not suitable for investors who cannot tolerate the risk of complete loss or who require liquidity.
The Ellington Income Opportunities Fund is distributed by Foreside Fund Services, LLC, not an adviser affiliate.