CMNIX: Staying on a Steady Course

CMNIX: Staying on a Steady Course

Eli Pars, CFA

Summary Points:

• Calamos Market Neutral Income Fund continued to notch steady returns over the quarter. Demonstrating the long-term benefits of a strategy with lower duration opportunity or risk, the fund outperformed the bond market across longer periods.
• CMNIX's alternative approach entails historically minimal interest rate opportunity or risk, which has served it well over complete interest rate and market cycles.
• We are confident in our ability to deliver steady performance now that the Fed has begun cutting rates.
• We continue to like the opportunities in hedged equity and convertible arbitrage. At quarter end, the fund's arbitrage and hedged equity allocation were roughly in line with each other and largely unchanged from the start of the quarter.

Performance Recap

For the quarter, the fund gained 2.48%, lagging a bond market that saw unusually strong performance, as measured by a return of 5.10% for the Bloomberg US Government/Credit Index. As a fixed-income alternative, Calamos Market Neutral Income Fund has lower exposure to duration opportunity and, perhaps more importantly for investors seeking consistent return outcomes, lower exposure to duration risk, unlike traditional bond funds.

CMNIX: Bond Market Outperformance over the Long Term

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.

Year-to-date through September 30, both CMNIX's convertible arbitrage and hedged equity sleeves contributed favorably to performance, and in roughly equal measure. During the third quarter, convertible arbitrage was up a bit more than hedged equity. Convertibles benefited from the volatility of the equity markets and a generally positive tone in the asset class. For the year, these two strategies generated quite similar returns.

The third quarter was nothing if not eventful, from President Biden's decision to step away from the presidential campaign, two attempts on the life of former President Trump, and a yen carry trade unwind to the long-awaited kickoff of Fed easing. A few weeks into the quarter, the S&P 500 was down by 5% only to reach all-time highs at the end of September following the Fed rate cut.

This initial drawdown was fast but not sustained, which meant the fund held up well, all things considered in our opinion. During the drawdown, and throughout the rest of the quarter, we took advantage of short-term volatility to rebalance hedges.

Some may wonder whether the change in the trend of the Fed funds rate is keeping us up at night. It is not. We've invested through many interest rate cycles and are confident that we can continue to deliver steady performance.

Calamos Market Neutral Income Fund (CMNIX) Has Outperformed Bonds Across Changing Interest Rate Regimes

Past performance is no guarantee of future results. Source: Morningstar Direct and St. Louis Federal Reserve as of 6/30/2024. "Rates near zero" period includes 3/16/2020-3/16/2022, "Aggressive tightening" period includes 3/17/2022 to 5/3/2023 and "Plateau" period includes 5/4/2023 to 6/30/2024. Returns are cumulative.

As we've emphasized, our strategy doesn't have much duration risk or opportunity. In contrast, bond funds are driven by changes in the curve. Rates for overnight money will go back down, which will weigh on return expectations, but only slightly. The impact of effective overnight money on our convert arb book mostly lags. Rebates on shorts come through right away, but coupons take longer. In the bond market, the lag isn't there, and it's possible that the bond market has already priced in a good part of the Fed's moves.

How We Are Positioned

Between the start and end of the quarter, our allocations went unchanged, although we were active in rebalancing our hedges and booking profits throughout the quarter. At the end of the quarter, hedged equity represented slightly more than half of the portfolio, followed by convertible arbitrage.

CMNIX Allocation: If It's Not Broken …

Hedged Equity Strategy

As the equity market increased during the quarter, our hedged equity strategy captured an attractive level of the upside. Indeed, the hedged equity strategy's defensive posture has continued to contribute decent returns while avoiding the brunt of market drawdowns. As discussed in our past commentaries, favorable capture has been supported by positive standstill yields in an environment of higher interest rates. As rates move down, the opportunity set will adjust, and we will rebalance accordingly. We've been here before, after all.

Arbitrage Strategy

Convertible arbitrage. Convertible arbitrage is a bottom-up trading strategy. The opportunity set remains attractive even as it has shrunk a bit, as new issuance tapered during the third quarter, and overall valuations in the convertible market were stable to slightly positive. That said, we're still finding plenty of opportunities to trade around our book and we would note that although issuance over the quarter may not have been great, year-to-date issuance is still good. Through September, global issuance totals $82 billion, led by the US at $52 billion. This compares with $61 billion and $41 billion, respectively, at this same point last year.

Global Convertible Issuance: Healthy Year-to-Date Levels ($bil)

Source: ICE BofA Global Research. Data through September 30, 2024.

We aren't overly concerned about the more modest issuance over recent months. Even though the Fed has lowered interest rates, convertible securities should remain an attractive choice for issuers seeking to lower their borrowing costs, and we continue to see new convertibles come to market with attractive terms. The equity market could enjoy a relief pop after the US presidential election, and we would not be surprised to see a rally drive a wave of issuance.

Merger arbitrage. Like convertible arbitrage, merger arbitrage is a bottom-up strategy, and the opportunity set is highly idiosyncratic. We are seeing especially exciting opportunities emerge in the energy sector, in all-stock transactions. Energy M&A has tended to avoid some of the biggest regulatory hurdles that have dogged other industries. Our team likes the opportunity set, and we believe consolidation can continue, opening the door to other interesting deals. (For more, see our post, "Merger Arbitrage: Energized by All-Stock Transactions in Oil & Gas.")

Closing Thoughts

Even though bond markets enjoyed a nice bounce this quarter, we believe bond market volatility isn't going anywhere, while the Fed will still be a source of anxiety for markets. And with two-year, five-year, and 10-year Treasuries all yielding around 3.5%, the bond market appears to already be pricing in most of the likely upside in this easing cycle. (For more on this theme, see "Has the Duration Trade Already Run its Course? It Depends.") For investors who want steady performance potential and don't want to worry about interest rate moves and bond market volatility, Calamos Market Neutral Income Fund checks all the boxes as a compelling fixed-income alternative.