RIMROCK LOW VOLATILITY FUNDS Performance Update July 2011

Transcription

1 The Rimrock Low Volatility Funds (the Funds ) are two separate funds managed in the same relative value, multi-sector fixed income style. The Funds have two different Master-Feeder structures, including the Rimrock Low Volatility Fund, which is open to accredited investors that meet the requirements detailed in section 3(c)(1) of the Investment Company Act of 1940, while the Rimrock Low Volatility (QP) Fund, which is open to qualified purchasers that meet the requirements detailed in section 3(c)(7) of the Investment Company Act of The strategy in both Funds is to exploit structural and technical inefficiencies in the market, especially in the short-end of the yield curve and to enhance the Funds risk-adjusted returns through careful security selection, modest leverage and active hedging. The Fund was up 1.1% for the month of July, bringing the year-to-date performance to up 3.8%, net of all fees and expenses. Performance Attribution On the last day of July, we got a resolution to the US debt ceiling crisis, which allowed everyone to breathe a momentary sigh of relief and then all hell broke loose. Over the last few months, the market has been trying to come to terms with a slower pace of global economic growth and the increased possibility of additional policy responses from central banks and governments around the world, which has resulted in the highest levels of volatility that we have seen since the dark days of Importantly, one of the keys that should prevent the current environment from blossoming into a kind of event is the significantly lower amount of leverage being employed in the system, including the leverage used by hedge funds. That being said, we ve been building the available cash and overall liquidity across our portfolios over the last few months in anticipation of being able to buy really cheap bonds that hold up to a wide range of economic outcomes. In addition, we ve constructed a well hedged portfolio to be able to withstand such bouts of volatility, changes in interest rates (duration) and spread widening, and we re pleased to report that our portfolios have held up well through July and the first half of August. Once again, the Fund received a positive contribution from our mortgage portfolio, including our exposure to non-agency residential mortgage-backed securities ( non-agency RMBS ), where we re focused on more seasoned collateral (read: 2004 and earlier) and bonds that have both a priority on principal prepayments and generate significant interest income for the portfolio. While there was some downward price pressure in this sector in July (and quite a bit more in August), our portfolio of mostly older vintage bonds with cleaner collateral and structures have fared better than their newer vintage ( ) or lower credit counterparts. Next, our relatively small exposure to interest-only ( IO ) and inverse IO mortgages also added to returns for the month, as the refinancing rate for residential mortgages remains very low. The Fund also received a positive contribution from our collection of high yield corporates, where we re focused on bonds that have 1) a priority position in the capital structure (i.e. senior secured or first lien), 2) a short average life, and 3) a significant balance sheet improvement via the bankruptcy process. Relative to the larger names in the high yield index, the companies in

2 our portfolio have low loan-to-value levels, strong collateral coverage, and pay a significantly higher yield compared to the high yield index. Our spread and default hedges, which include our short investment grade corporate and short emerging market debt positions detracted slightly from returns for the for the month, as we started to see spreads widen out towards the end of the month (and has continued into August). Meanwhile, our interest rate hedges were a small positive, as the increased volatility pushed up the value of some of our options that we are using to provide the portfolio with positive convexity. Our interest rate hedges are divided into three different positions; however they all share the similar characteristic of being low cost options that would introduce positive convexity if the markets were to experience what are currently discounted to be low probability events. First, we are long swaps and options on the Fed Funds rate over the next 12 months, so that if the Federal Reserve is forced to begin raising rates sooner than what the market anticipates, the Fund will benefit and would off-set some of the negative convexity associated with our inverse IO portfolio. (Since the Fed s announcement about keeping interest rates low for the foreseeable future, this position has been a negative in August.) Next, we are long a 2-year US curve flattener, which is specifically designed to help hedge the prepayment risk associated with our IO portfolio. And lastly, we are long a 15-year option, which if exercised allows us to pay (or be short) the 10-year US swap rate. Importantly, since we purchased the option, we can t lose more than the option premium that we paid, so we know the downside, and while volatility may be a near-term determinant of that position s value, it will benefit the portfolio if we see a meaningful increase in long-term rates. While our funds have demonstrated remarkably un-volatile returns over the last several quarters, we want to remind everyone that we expect to have the occasional down month or two (read: August), especially if the markets stay as volatile as we have seen over the last several months. Finally, we believe it s a great time to put capital to work in this space, as we continue to find exceptional higher-yielding paper with limited principal risk and then we spend a healthy amount of the portfolio s income on a variety of hedging strategies to be able to withstand this (and future) market volatility.

3 Net Performance Summary 2011 Performance Rolling Period Performance July QTD YTD 1-yr. 2-yr.* 3-yr.* 4-yr.* Since Inception* Rimrock Low Volatility Funds Composite 1.1% 1.1% 3.8% 11.5% 15.2% 12.4% 15.1% 15.9% S&P 500 Index -2.0% -2.0% 3.9% 19.6% 16.7% 2.8% -0.9% 0.0% Barclays Cap. Aggregate Bond Index 1.6% 1.6% 4.4% 4.5% 6.3% 6.8% 6.7% 6.2% Barclays Cap. High Yield Index 1.2% 1.2% 6.2% 11.4% 17.4% 13.1% 9.6% 8.2% DJ Credit Suisse Hedge Fund Index 1.0% 1.0% 2.6% 11.4% 10.8% 3.7% 3.1% 4.6% * Annualized Since Inception: January 2007 Past results are not necessarily indicative of future results. This information does not constitute an offer or solicitation to invest. Results are time weighted rates of return, and reflect reinvestment of interest and other earnings. Returns are preliminary and unaudited, and subject to change. Rimrock makes no representations, and it should not be assumed, that past investment performance is an indication of future returns. The net returns are after management fees and expenses, including a 1 % management fee and 20% performance fee with a 1-month LIBOR hurdle rate, through March 31, 2010, which were then changed to include a 0.75% management fee and 15% performance fee, with no hurdle rate. Beginning in May of 2011, the performance reported includes the composite return for both the Rimrock Low Volatility Fund and the Rimrock Low Volatility (QP) Fund. The Funds are subject to a variety of risks, including but not limited to: investments may be speculative and subject to a high degree of risk; investments may be illiquid; and an investor could lose all or a substantial amount of any investment in the Funds. Therefore, a potential investor considering an investment in any commingled investment vehicle should review this information in conjunction with the separate private placement memorandum for said fund for complete risk disclosures and other important information about the Fund before investing.

4 Past results are not necessarily indicative of future results. This information does not constitute an offer or solicitation to invest. Results are time weighted rates of return, and reflect reinvestment of interest and other earnings. Returns are preliminary and unaudited, and subject to change. Rimrock makes no representations, and it should not be assumed, that past investment performance is an indication of future returns. The net returns are after management fees and expenses, including a 1 % management fee and 20% performance fee with a 1-month LIBOR hurdle rate, through March 31, 2010, which were then changed to include a 0.75% management fee and 15% performance fee, with no hurdle rate. Beginning in May of 2011, the performance reported includes the composite return for both the Rimrock Low Volatility Fund and the Rimrock Low Volatility (QP) Fund. The Funds are subject to a variety of risks, including but not limited to: investments may be speculative and subject to a high degree of risk; investments may be illiquid; and an investor could lose all or a substantial amount of any investment in the Funds. Therefore, a potential investor considering an investment in any commingled investment vehicle should review this information in conjunction with the separate private placement memorandum for said fund for complete risk disclosures and other important information about the Fund before investing.

5 7/31/11 6/30/11 5/31/11 Total Fund Strategy Assets Under Management (millions) Rimrock Low Volatility Fund Rimrock Low Volatility (QP) Fund Portfolio Characteristics (Rimrock Low Volatility Fund) 7/31/11 6/30/11 5/31/11 Duration (yrs.) Spread Duration (yrs.) (1.31) (0.70) (0.92) Option Adjusted Spread (bps.) Yield (%) Income Portfolio (as % of NAV) 7/31/11 6/30/11 5/31/11 Notional Leverage Long Positions Sector Exposure CLO/CDO Commercial Mortgage-Backed Securities ( CMBS ) Corporate High Yield Corporate Investment Grade Other Structured Product Emerging Markets Non-USD denominated Emerging Markets USD denominated Residential Mortgage-Backed Securities ( RMBS ) Agency (Fannie, Freddie, FHA) Agency Derivatives (IO s and inverse IO s) Non-Agency Non-Agency Derivatives Hedging and Financing (as % of NAV) Cash Financing Interest Rate Hedges 4,993 5,003 4,113 Short ABS Short Corporates Short Emerging Markets If you have any questions or need any additional information, please contact Paul C. Westhead at , or via at [email protected].