Breaking Through as Bonds Fight to Break Even

Breaking Through as Bonds Fight to Break Even

Eli Pars, CFA

Summary Points:

• CMNIX gained during the quarter (+1.54%), while the bond market has stayed flat, as measured by the Bloomberg US Government Credit Index (0.05%).
• The fund has also surpassed the bond market over longer periods, thanks to an alternative approach that is not vulnerable to the level of interest rate risks that bonds entail.
• The hedged equity sleeve participated in the equity market's upside, and a robust convertible new issuance market continues to give us interesting opportunities.

Traditional bonds struggled to earn their coupons in the second quarter and are essentially flat year to date. The continued deferral of future interest rate cuts hasn't helped the case for bonds.

We believe the fund's recent and long-term performance also demonstrates the merits of our approach as an alternative to cash. In our last commentary, we noted that the fund's one-year return of more than 7% has still easily surpassed a fed funds rate of more than 5%, a backdrop currently in place-though perhaps for not much longer if markets are right about the Fed's timeline for cuts.

CMNIX Has Demonstrated Strength over Bonds through Interest Rate and Market Cycles

Source: Morningstar. Performance data quoted represents past performance, which is no guarantee of future results. Current performance may be lower or higher than the performance quoted. Please refer to Important Risk Information. The principal value and return of an investment will fluctuate so that your shares, when redeemed, may be worth more or less than their original cost. All performance shown assumes reinvestment of dividends and capital gains distributions. The fund's gross expense ratio as of the prospectus dated 3/1/2024 is 0.97% for Class I shares.

We continue to like the trades we have on in convertible arbitrage and hedged equity, and we have maintained a roughly balanced allocation between the arbitrage and hedged equity sleeves.

CMNIX Allocation

Arbitrage Strategies

Our arbitrage strategies generally continued to perform well, anchored by our convertible arbitrage book. We continue to like the opportunity set in convertible arbitrage and are excited about the prospects offered by a growing new issue calendar. The second quarter saw more than $34 billion in global issuance, taking the first half total to $60.2 billion.

Over the past year, we have written extensively about the maturity walls in investment grade and high yield debt providing fuel to the convertible new issue market as companies seek to refinance debt at the lower borrowing costs associated with issuing convertibles instead of nonconvertible debt. We are seeing this play out, albeit at a modest pace. Part of our thesis has been that we would see an uptick in investment-grade convertible issuance as well, given a higher interest rate backdrop. This is also happening, with investment grade issuers accounting for almost one-third of the second quarter's issuance. This included a $5 billion new issue for an A-rated Chinese online retailer, one of the largest convertible bond issues we have ever seen.

Global Convertible Issuance Provides a Favorable Backdrop for Convertible Arbitrage

Source: BofA Global Research. Data as of June 30, 2024.

Hedged Equity

The opportunity set in the options market has allowed the fund's hedged equity strategy to maintain its defensive posture while still earning a decent return. This favorable capture has been driven by the positive standstill yield our hedge generates in a world of higher interest rates. More specifically, the recent rise in the fed funds rate flows through to the option market in higher call and lower put prices. (For more on this, see our video blog "Higher Rates are an Opportunity for Hedged Equity Strategies," where Dave O'Donohue walks through how higher rates impact option pricing.) We anticipate keeping this hedge profile as long as we find it the most attractive trade in the option market.