Hortz: How is it that CMBS can be less susceptible to the negative effects of rising interest rates? What makes CMBS a more “all-weather” asset class?
Sedmak: Although much of the CMBS market is fixed rate, there is also a significant supply of floating-rate CMBS available. In a rising interest rate environment, we’ve invested a fair portion of the Ladder Select Bond Fund in floating-rate senior bonds and kept duration pretty short for fixed-rate investments. By sticking mostly to the senior part of the capital structure with holdings principally in investment grade-rated bonds, the seniority of the security also helps to mute price volatility because of expected payoffs at par within a reasonable timeframe. We’ve traditionally focused on more senior and shorter term bonds which aren’t “sexy” but have produced a reliable and less volatile stream of cash flow.
Hortz: What other strategies does your firm use to unlock value from commercial real estate securities across market cycles?
Sedmak: We stick to our knitting and focus exclusively on what we know. We take a conservative approach, typically stay senior in the capital structure and are careful on duration. We believe our ability to perform fundamental bottom-up analysis has helped us to generate attractive relative returns with muted volatility, even in volatile macro market conditions. Bottom line: we try to keep it simple and focus on what we know best.
Hortz: What might be some still lingering concerns about commercial mortgage-backed securities (CMBS) from the market sell off in 2009 and its historic liquidity characteristics?
Harney: Like many asset classes CMBS was re-priced by the Financial Crisis, but the impact was muted and relatively short-lived compared to the residential / single-family home markets. To some degree, the favorable supply and demand dynamic and more conservative underwriting standards we’re seeing today are a direct result of the Financial Crisis. Staying senior in the capital structure further mitigates risk through credit enhancement. CMBS made up about 2 percent of the total U.S. fixed income market as of year-end 2018, so it’s a significant and growing portion of the fixed income sector with plenty of institutional investor participation.
A large and liquid CMBS market is now accessible, due to a liquid, institutionally dominated, secondary market of 20-plus years. The most active issuers of Agency CMBS are Fannie Mae, Freddie Mac and Ginnie Mae. These factors enhance market liquidity, especially for the more senior investment grade-rated bonds we favor.
Hortz: Why are there few, if no other, mutual funds with a strictly Commercial Real Estate Finance/CMBS orientation?
Harney: We believe a portfolio of commercial real estate finance investments / CMBS bonds is best managed by professionals with deep expertise in the field, and many investment professionals just don’t have the necessary experience to manage a CMBS mutual fund. In real estate, many investors take on significant risk to generate outsized yields, whereas we go the other way and seek strong protection of principal via highly‐rated senior secured bonds. We like this approach for the long‐term and it’s consistent with Ladder’s approach with its own capital. We’re pleased that this approach makes us fairly unique in the world of daily liquidity funds.
Hortz: How best would you recommend advisors employ your fund for their client portfolios?