FOURTH QUARTER 2019 RS MANAEMENT QUDT REORT - Masters Funds · 2020-03-25 · would be flexible and opportunistic. As advisors to the fund, we rely on the judgment of these experienced,

RISK MANAGEMENT & LIQUIDITY REPORTLITMAN GREGORY MASTERS ALTERNATIVE STRATEGIES FUND

WWW.MASTERSFUNDS.COM

LITMAN GREGORY MASTERS ALTERNATIVE STRATEGIES FUND

WWW.MASTERSFUNDS.COM

FOURTH QUARTER 2019

This information is authorized for investment advisors, broker/dealers, and other registered financial professionals only.

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CONTENTS

Highlights......................................3

Qualitative Discussion.....................4

Quantitative Analysis......................8

Contact......................................16

Disclosure....................................17


HIGHLIGHTS

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The fund is designed to have significantly lower risk and volatility than the stock market

Risk managed by sub-advisors at strategy level and by Litman Gregory at fund level

Tactical adjustments can be made to take advantage of opportunities or reduce risk

Experienced, risk-conscious sub-advisors managing complementary strategies

• Daily portfolio transparency• Credit Line of $125 million• Managers may invest a modest amount in illiquid assets• Currently holding less than 2% in illiquid assets

Litman Gregory can remove managers or liquidate assets at any time

LIQUIDITY FACTORS

Past performance is not a guarantee of future results.

QUALITATIVE | RISK MANAGEMENT & LIQUIDITY


Litman Gregory’s Overall Risk Management Expectations for the Alternative Strategies Fund:

• Target volatility: 4%–8%• Low beta to the equity market• Relatively low correlation to equity and bond markets• Lower drawdowns than the equity market

RISK MANAGEMENT PHILOSOPHY AND PROCESS

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Litman Gregory Fund Advisors created the Litman Gregory Masters Alternative Strat-egies Fund as a core, all-weather alternative investment: A fund that is intended to deliver attractive returns over full market cycles but with meaningfully lower risk than equities.

We designed the fund first and foremost with a strong focus on risk management, but we also sought to deliberately include underlying managers and strategies that would be flexible and opportunistic. As advisors to the fund, we rely on the judgment of these experienced, risk-averse managers (who have all invested through multiple market cycles) to decide when their respective opportunity sets are more versus less attractive, and to invest accordingly. We expect them to preserve capital, but also to invest more aggressively when they’re being well-compensated for the risks they assume with our shareholders’ capital.

The levels of risk management within the fund are threefold: first, at the sub-advi-sor level; second, in Litman Gregory’s monitoring of the sub-advisors’ portfolios; and third, in Litman Gregory’s overall portfolio management.

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LITMAN GREGORY’S MANAGEMENT OVERSIGHTLitman Gregory’s oversight of the fund includes two levels of risk management:

Sub-advisor oversight: We believe the sub-advisors’ judgment and risk management are the primary elements in the process, and thus we try to keep our micro-level involvement in their investment decisions to a minimum. However, we do actively monitor their portfolios with a focus on understanding the material exposures, re-turn drivers, and most significant potential risks.

This includes:

• Monthly manager-generated exposure reports

• Daily manager performance monitoring

• Daily transparency into managers’ trading

• Monthly third-party risk reporting at manager level

• Periodic conversations with managers

Portfolio oversight: The fund is diversified by asset class and strategy. By design, we do not believe it should be heavily dependent on broad stock or bond market condi-tions for its long-term success, nor should it be dependent on frequent adjustments to the underlying managers or allocations. Ultimately, our job as portfolio managers is to select high-quality sub-advisors who manage complementary strategies and ensure they are faithfully executing their investment process within their (typically broad) mandate. We then continually revisit our investment theses for the sub-advi-sors, as well as the appropriateness of the capital allocations to each manager, and assess the risks and return drivers in the portfolio.

This includes:

• Daily position-level and trade transparency

• Daily fund-level performance monitoring

• Fund-level asset-class and strategy exposure tracking

• Third-party risk reporting at fund level

• Third-party liquidity reports

Further, we have the ability to hedge at the portfolio level, although we are unlikely to do this. Since the fund is composed of a group of separately managed accounts custodied at State Street, we can also pull capital from managers at any time, or reallocate away from risks we perceive to be too high.

Two of the sub-advisors (Water Island and DoubleLine) have the ability to use limited leverage (less than 10% of fund NAV combined).

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DCI’s risk management is characterized by a conservative overall approach, avoidance of concentrated risk exposures, and proactive de-risking of deteriorating exposures. DCI leverages its technology to produce timely risk measures for thou-sands of issuers; these are monitored in real-time, providing early warning capabilities that enable the firm to reduce or eliminate positions that could become problematic.

The firm’s empirical research and management experience have enabled the team to identify several risk factors that DCI believes contribute meaningfully to credit portfolio performance. Exposure to each of these factors (e.g., credit market beta, interest rate risk, sector, geography) in DCI’s portfolios are measured, reported, and controlled by a Risk Committee–approved limit.

In addition to the factor risk limits, there are issuer specific limits: a maximum target weight of 2% for a single issuer in the long and short credit default swap portfolios as well as a maximum target weight of 2% for a single issuer in the high-yield portfolio. Interest rate risk is hedged to a conservative duration (less than two years) through interest rate swaps and/or Treasury futures.

DoubleLine uses a number of systems to calculate and monitor the various interest rate and credit rating risks of the port-folio, including YieldBook to calculate the effective duration and convexity characteristics of agency mortgage-backed se-curities (MBS), and Intex and Bloomberg (along with scenario analysis) to calculate the effective duration and convexity of the non-agency MBS. The firm believes these methodologies allow them to more accurately assess the interest rate risk in the portfolio than they could by relying upon any individual system. They monitor the credit risk of the portfolio via inputs from Intex, Vichara, and Loan Performance. This allows for aggregation of the credit risks at the portfolio level in addition to the credit risk of individual securities.

Scenario analysis is the primary driver of asset allocation, risk management, and security selection. Securities are ana-lyzed under various scenarios that are customized by the portfolio managers based upon their years of experience in the mortgage market and by current market conditions. DoubleLine believes this process allows for a better understanding of risk than using a purely model-based methodology. The portfolio managers take a “risk integration” approach in con-structing the portfolio, thinking about how different securities and exposures will perform as a whole in various scenarios rather than viewing the various components in isolation. The firm shuns risk-taking based on unidirectional forecasts, instead preferring to build a portfolio that can perform reasonably well under multiple scenarios.

FPA’s primary goal is to protect capital while also trying to create long-term equity-like returns. The portfolio managers are absolute-value investors who try to invest in things that are cheap on an absolute basis rather than securities that are only cheap relative to other alternatives. They look for positions that they believe offer a compelling economic risk/reward proposition, and if prospective investments do not meet that requirement, the managers will hold cash and wait until they find investments that do. FPA believes that risk is unavoidable when investing, but the portfolio managers attempt to min-imize the chance of permanent capital impairment.

FPA rejects volatility as a measure of investment risk and believes that if their research is good, volatility should present long-term opportunity. However, they also recognize that very high volatility may not serve investors well, as it can cre-ate stress and potentially cause investors to sell at precisely the wrong times. Lower volatility is not the explicit goal of the strategy, but it has proven to be a natural by-product. FPA spends a disproportionate amount of time evaluating and managing investment, company-specific, and economic risk. While they are not macro investors, they do incorporate their understanding of the economic environment in their investment process and portfolio construction. Ultimately, FPA be-lieves that if they successfully limit the downside by conducting thorough research, using conservative assumptions, and remaining disciplined on price, the upside will take care of itself over the long term.

THE ALTERNATIVE STRATEGIES FUND SUB-ADVISORS’ APPROACH TO RISK MANAGEMENT


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Loomis Sayles tries to generate returns from (and manage) three key risk drivers, or betas, that can be harvested within fixed-income. They refer to them as the “3Cs”: curve (i.e., the yield curve), credit, and currency risk. The team begins by looking at macroeconomic factors, which typically drive investment cycles, which in turn can drive asset class behavior. By properly identifying and analyzing the different phases of the investment cycle (credit repair, recovery, expansion/late cy-cle, downturn), Loomis Sayles seeks to profit by tactically adjusting exposures to these risk drivers throughout each phase. Investment ideas are judged in part on the expected return being at least equal to or greater than the perceived drawdown, and the mitigation of drawdown risk is a key component of the strategy. Frequent stress-testing of the portfolio is invalu-able in estimating drawdown potential and in subsequently making active adjustments to maintain the desired level of risk. They believe this active process is especially important during periods of rising rates, when interest rate exposure may not provide the same portfolio benefits as it does when rates are falling. Proper beta management requires a disciplined hedging strategy coupled with the use of sophisticated quantitative tools that can accurately measure top-down risks that originate from the 3Cs. This is done both in isolation and on an aggregate basis, taking into account how the different beta risks interact. Working with Loomis Sayles’s Quantitative Research & Risk Analysis group, the portfolio managers have developed a number of hedging strategies using liquid interest rate, credit, and currency derivatives that can quickly and efficiently adjust the expected level of risk stemming from each of the 3Cs.

Water Island takes a proactive approach to risk management, striving to diversify exposures across geography, market capitalization, sector, industry, and type of corporate event, while also employing the use of options, short selling, and other hedging strategies and tools to offset event and market risk. Portfolio managers within each of the sub-strategies (merger arbitrage, equity special situations, and credit opportunities) monitor risk at the position level. The portfolio man-agers track idiosyncratic event risk factors, including regulatory considerations, deal strength (strategic rationale, hostile approach, termination fee), financing risk (pro-forma leverage, cash/stock), and other factors (tax inversion, commodity exposure, cyclical industry, shareholder vote considerations). They try to dynamically assess worst-case loss scenarios from deal or event breaks and typically size positions so as not to lose more than 1% on a single position. The portfolio managers actively hedge currency exposure in foreign positions and interest rate risk in credit-based positions. At the port-folio level, the Chief Risk Officer aggregates and monitors exposure to various risk factors across the different sub-strate-gies, performs scenario analysis and stress-testing, monitors macro risks, and also works with the portfolio managers to formulate efficient hedging strategies. He may also implement portfolio-level hedges during distressed markets.

DCI Long-Short Credit

19%

DoubleLine Opportunistic Income

25%

FPA Contrarian

Opportunity18%

Loomis Sayles Absolute Return

19%

Water Island Capital Arbitrage and Event-Driven

19%

TARGET SUB-ADVISOR ALLOCATION

As of 12/31/2019.

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QUANTITATIVE | RISK MANAGEMENT & LIQUIDITY


ASSET CLASS ALLOCATION

ASSET CLASS BREAKDOWN

U.S. Corporate Bonds26.8%

Non-Agency RMBS21.1%

Equity21.8%

Cash & Equivalents11.2%

Other8.0%

Agency RMBS5.3%

Sovereign3.0%

Bank Loans2.8%

Municipal Securities0.2%

Sector NPV

U.S. Corporate Bonds 535,168,143

Non-Agency RMBS 421,144,381

Equity 435,215,154

Cash & Equivalents 224,168,640

Other 159,098,284

Agency RMBS 105,734,174

Sovereign 59,440,687

Bank Loans 56,142,882

Municipal Securities 4,410,577

As of 12/31/2019.


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SECTOR ALLOCATION

SECTOR BREAKDOWN

Mortgage Securities18.0%

Other12.7%

Cash & Equivalents11.2%

Financial9.5%

Communications9.5%

Asset-Backed Securities8.4%

Consumer Non-Cyclical7.6%

Consumer Cyclical7.6%

Industrial7.3%

Technology4.1%

Energy4.3%

Sector NPV

Mortgage Securities 359,517,651

Other 253,831,233

Cash & Equivalents 224,168,640

Financial 190,034,985

Communications 190,122,826

Asset-Backed Securities 167,360,904

Consumer Non-Cyclical 151,440,390

Consumer Cyclical 152,585,262

Industrial 145,046,040

Technology 81,151,504

Energy 85,263,487

As of 12/31/2019.

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LIQUIDITY AMOUNT BY ASSET CLASS

0

500

1,000

1,500

2,000

3-Days 7-Days 15-Days 30-Days

Mill

ions

Fixed-Income Equity Cash Other

Assets 3 Days Assets 7 Days Assets 15 Days Assets 30 Days

Grand Total 1,392,645,519 1,625,236,978 1,813,457,986 1,948,483,568

U.S. Corporate Bonds 310,936,454 427,716,541 508,962,532 526,245,652

Equity 505,010,228 512,658,652 513,829,381 513,829,641

Non-Agency Structured Product 109,660,178 181,637,325 271,380,999 373,976,231

Cash & Equivalents 196,216,742 196,216,742 196,216,742 196,216,742

Agency Structured Product 113,087,693 113,087,693 113,087,693 113,087,693

FX, Credit, and Other Derivatives 49,807,861 64,409,761 79,918,181 94,478,529

Sovereigns 67,929,288 68,108,785 68,467,780 68,692,151

Bank Loan 31,961,705 53,269,509 53,269,509 53,269,509

Municipal Securities 6,142,416 6,239,016 6,432,216 6,794,466

Preferred Stock 1,892,954 1,892,954 1,892,954 1,892,954

LIQUIDITY BREAKDOWN

As of 12/31/2019.

Asset Total includes the cash collateral held for short positions and derivatives.


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ASSET & REDEMPTIONS PROFILE

-37 -56

-187-280

1,314

1,539

1,715

1,886

1,277

1,483 1,5281,606

-500

-250

0

250

500

750

1,000

1,250

1,500

1,750

2,000

2,250

2,500

3 Days 7 Days 15 Days 30 Days

Mill

ions

Redemptions Assets Net

REDEMPTION RATIOS3 Days 7 Days 15 Days 30 Days

Assets 1,314,396,228 1,539,131,484 1,714,569,376 1,885,578,639

Redemptions (37,318,442) (55,977,663) (186,592,208) (279,888,313)

Redemption Ratio (Assets/Redemptions) 35.2 27.5 9.2 6.7

As of 12/31/2019.

Redemption calculations are made by an independent third-party model to project redemption ratios over 3-, 7-, 15-, and 30-day time periods.

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60/40 TRADITIONAL PORTFOLIO

STRESS TEST RESULTS

-30.0%

-25.0%

-20.0%

-15.0%

-10.0%

-5.0%

0.0%

5.0%

Black Monday (10/16/87–10/19/87)

Asian Crisis (11/17/97–12/15/97)

Russian Debt Crisis (8/17/98–9/8/98)

9/11 Attack (9/10/01–9/11/01)

Lehman Bankruptcy (9/12/08–9/15/08)

Credit Crisis (9/15/08–10/13/08)

March 2009 (2/2/09–3/9/09)

-5.4%

0.0%

-6.6%

-1.9% -1.5%

-7.2% -6.2%

P/L

Nav

%

As of 12/31/2019. 60/40 Tradtional Portfolio consists of 60% S&P 500 Index and 40% Bloomberg Barclays U.S. Aggregate Bond Index. Indexes are unmanaged and cannot be invested into directly. Stress Test Results are generated by an independent third-party model to project the performance of the fund over event-specific time periods.


-30.0%

-25.0%

-20.0%

-15.0%

-10.0%

-5.0%

0.0%

5.0%

Black Monday (10/16/87–10/19/87)

Asian Crisis (11/17/97–12/15/97)


9/11 Attack (9/10/01–9/11/01)


Credit Crisis (9/15/08–10/13/08)

March 2009 (2/2/09–3/9/09)

-11.5%

2.9%

-3.9%

-6.4%

-2.5%

-13.4%

-10.4%

P/L

Nav

%


13


S&P 500 INDEX

BLOOMBERG BARCLAYS U.S. AGGREGATE BOND INDEX

As of 12/31/2019. Stress Test Results are generated by an independent third-party model to project the performance of the fund over event-specific time periods.

-30.0%

-25.0%

-20.0%

-15.0%

-10.0%

-5.0%

0.0%

5.0%

Black Monday (10/16/87–10/19/87)

Asian Crisis (11/17/97–12/15/97)


9/11 Attack (9/10/01–9/11/01)


Credit Crisis (9/15/08–10/13/08)

March 2009 (2/2/09–3/9/09)

-26.3%

3.9%

-7.7%

-11.6%

-4.5%

-19.7%

-17.7%

P/L

Nav

%

-30.0%

-25.0%

-20.0%

-15.0%

-10.0%

-5.0%

0.0%

5.0%

Black Monday (10/16/87–10/19/87)

Asian Crisis (11/17/97–12/15/97)


9/11 Attack (9/10/01–9/11/01)


Credit Crisis (9/15/08–10/13/08)

March 2009 (2/2/09–3/9/09)

3.6%

1.0%2.1%

-0.3%

0.1%

-3.5%

-0.3%

P/L

Nav

%

14



Redemption Shock

Days to Liquidate

Black Monday

(10/16/87–10/19/87)

RR

Asian Crisis (11/17/97–12/15/97)

RR

Russian Debt Crisis (8/17/98–

9/8/98) RR

9/11 Attack (9/10/01–9/11/01)

RR

Lehman Bankruptcy

(9/12/08–9/15/08)

RR

Credit Crisis (9/15/08–10/13/08)

RR

March 2009 (2/2/09–3/9/09)

RR

1.0

3 Days 33.8 37.2 33.7 36.1 36.2 33.4 33.7

7 Days 26.8 28.9 26.3 28.2 28.3 26.2 26.5

15 Days 9.1 9.7 8.8 9.5 9.5 8.8 9.0

30 Days 6.5 6.9 6.3 6.8 6.8 6.4 6.5

1.2

3 Days 28.2 31.0 28.1 30.1 30.1 27.9 28.1

7 Days 22.3 24.1 21.9 23.5 23.6 21.9 22.1

15 Days 7.5 8.1 7.4 7.9 7.9 7.4 7.5

30 Days 5.4 5.8 5.3 5.6 5.7 5.3 5.4

1.4

3 Days 24.2 26.5 24.1 25.8 25.8 23.9 24.1

7 Days 19.1 20.7 18.8 20.1 20.2 18.7 19.0

15 Days 6.5 6.9 6.3 6.8 6.8 6.3 6.4

30 Days 4.7 5.0 4.5 4.8 4.9 4.5 4.6

1.6

3 Days 21.2 23.2 21.0 22.6 22.6 20.9 21.0

7 Days 16.7 18.1 16.4 17.6 17.7 16.4 16.6

15 Days 5.7 6.1 5.5 5.9 5.9 5.5 5.6

30 Days 4.1 4.3 4.0 4.2 4.3 4.0 4.0

1.8

3 Days 18.8 20.6 18.7 20.1 20.1 18.6 18.7

7 Days 14.9 16.1 14.6 15.7 15.7 14.6 14.7

15 Days 5.0 5.4 4.9 5.3 5.3 4.9 5.0

30 Days 3.6 3.9 3.5 3.8 3.8 3.5 3.6

STRESSED COVERAGE RATIOS

As of 12/31/2019.

Stressed Coverage Ratios are the result of an independent third-party model to project redemption ratios over 3-, 7-, 15-, and 30-day time periods.

AUM:$1.85B

VaR 99%:-0.7%

Max Loss:-0.8%

As of 12/31/2019.

VaR 99%: Value at Risk is a measurement of risk by an independent third-party model and estimates how much a portfolio may lose, given normal market conditions, over a one-day period.

Max Loss: Maximum Loss is a measurement of risk by an independent third-party model that estimates the maximum foreseeable loss or worst-case scenario, given normal market conditions, over a one-day period.

15

NOTES

16This information is authorized for investment advisors, broker/dealers, and other registered financial professionals only.

National Director of Institutional [email protected]

LITMAN GREGORY MASTERS FUNDS

Scott Jones

Mike Pacitto

CONTACT US

Institutional Relationship [email protected]

Larkspur | Palo Alto | San Francisco | Walnut Creek

1676 N. California Blvd., Suite 500Walnut Creek, California 94596www.mastersfunds.comMAIN LINE 925.254.8999FAX 925.254.0335

Mike Pacitto, Scott Jones, and Mark Adams are registered representatives of ALPS Distributors, Inc.

Mark AdamsInstitutional Relationship [email protected]

17

The fund’s investment objectives, risks, charges, and expenses must be considered carefully before investing. The statutory and summary prospectus contains this and other important information about the investment company, and it may be obtained by calling 1-800-960-0188. Read it carefully before investing.All charts and graphs sourced from State Street.

Although the managers actively manage risk to reduce portfolio volatility, there is no guarantee that the fund will always maintain its targeted risk level, especially over shorter time periods and loss of principal is possible. The performance goals are not guaranteed, are subject to change, and should not be consid-ered a predictor of investment return. All investments involve the risk of loss and no measure of perfor-mance is guaranteed. The fund aims to deliver its return over a full market cycle, which is likely to include periods of both up and down markets.

Though not an international fund, the fund may invest in foreign securities. Investing in foreign securities exposes investors to economic, political and market risks, and fluctuations in foreign currencies. Investments in debt securities typically decrease when interest rates rise. This risk is usually greater for longer-term debt securities. Investments in mortgage-backed securities include additional risks that investor should be aware of including credit risk, prepayment risk, possible illiquidity, and default, as well as increased susceptibility to adverse economic developments. In-vestments in lower-rated and non-rated securities present a greater risk of loss to principal and in-terest than higher-rated securities. Derivatives may involve certain costs and risks such as liquidity, interest rate, market, credit, management, and the risk that a position could not be closed when most advantageous. Multi-investment management styles may lead to higher transaction expenses compared to single investment management styles. Outcomes depend on the skill of the sub-advi-sors and advisor and the allocation of assets amongst them.

Investing in derivatives could lose more than the amount invested. The fund may make short sales of securities, which involves the risk that losses may exceed the original amount invested. Merger arbitrage investments risk loss if a proposed reorganization in which the fund invests is renegotiat-ed or terminated.

Investment in absolute return strategies are not intended to outperform stocks and bonds during strong market rallies.

Diversification does not assure a profit nor protect against loss in a declining market.

Leverage may cause the effect of an increase or decrease in the value of the portfolio securities to be magnified and the fund to be more volatile than if leverage was not used.

Fund holdings and/or sector allocations are subject to change at any time and are not recommendations to buy or sell any security.

Past performance is no guarantee of future results.

Mutual fund investing involves risk. Principal loss is possible.

Litman Gregory Fund Advisors, LLC has ultimate responsibility for the performance of the Litman Gregory Masters Funds due to its responsibility to oversee the funds’ investment managers and recommend their hiring, termination, and replacement.Neither the information contained herein nor any opinion expressed shall be construed to constitute an offer to sell or a solicitation to buy any security or any other funds mentioned herein. The views herein are those of Litman Gregory Fund Advisors, LLC at the time the material is written and may not be reflec-tive of current conditions.

The Litman Gregory Masters Funds are Distributed by ALPS Distributors, Inc. LGM000815 exp. 4/25/2020

DISCLOSURE


AUGUST 31, 2017

WWW.MASTERSFUNDS.COMWWW.MASTERSFUNDS.COM

Documents

FOURTH QUARTER 2019 RS MANAEMENT QUDT REORT - Masters Funds · 2020-03-25 · would be flexible and opportunistic. As advisors to the fund, we rely on the judgment of these experienced,