Litman Gregory Masters Alternative Strategies Fund Fourth Quarter 2017 Attribution

The Litman Gregory Masters Alternative Strategies Fund (Institutional Share Class) gained 0.67% for the quarter ending December 31, 2017.i During the same period, the Morningstar Multialternative Category gained 1.72% and 3-month LIBOR returned 0.34%. For the full year, the fund gained 4.51%, while the Morningstar category and 3-month LIBOR returned 5.57% and 1.21%, respectively.

Performance quoted represents past performance and does not guarantee future results. The investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance of the funds may be lower or higher than the performance quoted. To obtain standardized performance of the funds, and performance as of the most recently completed calendar month, please visit

Quarterly Review

At the end of the fourth quarter, we removed Passport from the fund. The decision was fairly straightforward, as the firm was changing materially and chose to focus on a much narrower set of opportunities, while closing their flagship hedge fund to concentrate on what we considered more niche strategies. The fund’s new strategic/target weightings are 25% to DoubleLine, 19% each to DCI, Loomis Sayles, and Water Island, and 18% to FPA. Our decision on the new allocations reflects our high conviction in each manager/strategy and our desire to maintain a relatively balanced, simple allocation that we believe should provide good results over time and across a number of potential macro and market scenarios, rather than being optimized or continuously tweaked for what may appear to be the most likely scenario at any point in time (at the potential cost of significantly worse results if markets follow a different path). As we have conveyed previously, we believe it is quite difficult to consistently predict macroeconomic outcomes, and even then, market reaction may not result in profits even if the macro prediction is correct. On rare occasions, if we see an extremely compelling return opportunity, we may tactically overweight a manager/strategy to further benefit from it. (We have done this once so far in the fund’s life.) Our managers also have significant flexibility within their mandates to vary their portfolio and risk exposures, driven by their assessment of the reward-versus-risk within their investment universes.

However, we do make distinctions in strategic weightings based on the differing return profiles and other characteristics of the sub-advisors. As such, we have given DoubleLine the largest allocation based on the strategy’s strong returns and low historical correlation with other sub-advisors and equity markets. (Current positioning obviously matters as well, since we do not blindly rely on historical numbers without considering how things may have changed over time.) The other sub-advisors have performed within our range of expectations and we are very satisfied with the overall portfolio. FPA’s contribution to the fund’s volatility is somewhat higher than other managers’ individual contributions, despite a near equal dollar weighting, which is expected given their strategy. This volatility contribution (and higher correlation with equity markets) is what leads us to essentially equal-weight FPA with the other three sub-advisors, despite our expectation for FPA to produce among the highest long-term absolute returns.

We continue to evaluate new strategies and managers, but as we have always said, we don’t feel the need to “check a box” in every alternative category, so we are not devoting all our energy searching for a long/short equity manager as an explicit replacement for Passport. Our goal is always finding high-conviction strategies that complement each other and aggregate to a portfolio that can meet the fund’s objectives. If and when we find a long/short equity manager we think is very distinctive and also fits well in the portfolio, we will certainly add it, but it’s definitely far from our exclusive focus.

Fund performance was fine in 2017 but nothing to write home about compared to buoyant equity markets. This is to be expected, as the fund is not designed, nor are our managers inclined, to try to keep up with levitating markets at the expense of discipline and risk management. The fund is not intended to track any market index, and given its relatively conservative positioning, we are satisfied with the performance on the year, although we always hope to do better. We know better opportunities for our managers to commit capital will come—and believe they are well positioned to do so—but we can never know exactly when.

Litman Gregory Masters Alternative Strategies Fund Risk/Return Statistics 12/31/17
Bloomberg Barclays Agg Bond
Russell 1000
Morningstar Multi-Alternatives Category
Annualized Return
5.3 2.53 17.23 2.13
Total Cumulative Return
38.09 16.92 170.08 14.06
Annualized Std. Deviation
3.1 2.69 10.32 3.09
Sharpe Ratio (Annualized)
1.6 0.85 1.58 0.62
Beta (to Russell 1000)
0.25 -0.03 1 0.26
Correlation of MASFX to…
1 -0.12 0.79 0.81
Worst Drawdown
-6.94 -4.52 -12.41 -8.21
Worst 12-Month Return
-4.49 -2.47 -7.21 -6.08
% Positive 12-Month Periods
88.06 82.09 95.52 77.61
Upside Capture (vs. Russell 1000)
30.64 8.27 100 21.69
Downside Capture (vs. Russell 1000)
27.64 -8.3 100 41.67
Since inception (9/30/11).
Worst Drawdown based on weekly returns
Past performance is no guarantee of future results





Quarterly Portfolio Commentary

Performance of Managers

For the quarter, five of the six managers produced positive returns, although only two were above 100 basis points. FPA’s Contrarian Opportunity strategy gained 3.03%, Water Island’s Arbitrage and Event-Driven strategy rose 1.06%, Loomis Sayles’s Absolute-Return Fixed-Income strategy was up 0.88%, DCI’s Long-Short Credit strategy gained 0.17%, and Passport’s Long-Short Equity strategy was essentially flat, with a positive 0.01% return. DoubleLine’s Opportunistic Income strategy was the sole negative performer during the quarter, producing a return of negative 0.53%. (All returns are net of the management fee each sub-advisor charges the fund.)

Key performance drivers and positioning by strategy

DCI: DCI’s Long-Short Credit strategy gained 0.2% in the fourth quarter. A negative December return partially offset gains from October and November and dropped returns since the July inception date down to approximately 1.0%. Performance was slightly positive in both the CDS (Credit Default Swap) and Bond sleeves. The various strategy components continue to be nicely diversified and not overly driven by market beta or other macro themes.

During the quarter, the CDS sleeve generated modest gains as profits in the consumer, transport, and banking sectors were somewhat offset by losses in insurance, hospital, and equipment names. A long position in Bombardier was the biggest gainer. The Bond sleeve gained on long positions in high-quality names in the energy, materials, tech, and transport sectors, which were somewhat offset by losses in telecoms. Valeant Pharmaceuticals International was the biggest gainer, while Intelsat was the biggest loser.

Hedges were a net drag for the quarter as credit spreads steadily tightened. Credit sentiment was further boosted over the quarter by the continued strong economic picture and the impending corporate tax cut. The credit hedge performed a bit worse than expected as investors bid up synthetic credit exposure into the year-end (on the margin hurting the strategy’s CDX (Credit Default Index) hedge, compared to its cash bond longs).

Overall, strategy performance has been acceptable, but somewhat below long-term expectations. Positioning continues to seek out the best credit-selection opportunities and has been relatively stable, although with a bit less conviction of late. Longs in consumer goods against shorts in telecom are the most notable sector view, while the strategy has taken profits on its retail shorts, with offsetting reductions in hospital and equipment names. Looking forward, the opportunity set for performance gains in the new year looks promising, with the potential to generate better absolute returns when volatility increases from its historic lows.

DoubleLine: The DoubleLine Opportunistic Income strategy declined 0.5% in the fourth quarter, underperforming the Bloomberg Barclays U.S. Aggregate Bond Index return of 0.39%. This underperformance was primarily due to weakening valuations on Puerto Rico muni bonds after Hurricane Maria in September, as the ultimate resolution of the debt restructuring amid a humanitarian disaster became less clear, both in terms of timing and recovery value for creditors. The U.S. Treasury curve also flattened during the period with 2-year and 10-year Treasury yields up 40 basis points (bps) and 7 bps, respectively. This resulted in declining valuation across agency residential mortgage-backed securities (RMBS) with inverse interest-only securities as the worst-performing sector. Agency fixed-rate collateralized mortgage obligations (CMO) outperformed as valuations improved. Amongst non-agency RMBS, prices weakened slightly during the quarter; however, total return was positive due to interest income. Within the non-agency sector, subprime securities outperformed as prices rose. Other structured credit sectors such as collateralized loan obligations (CLO) and commercial mortgage-backed securities (CMBS) contributed positively to performance due primarily to interest income. Other asset-backed securities (ABS) underperformed as valuations declined during the quarter.

The strategy remains balanced in terms of its return drivers, with credit-sensitive sectors (primarily non-agency RMBS) accounting for nearly 70% of the portfolio, balanced by mostly longer-duration, interest rate–sensitive agency securities (approximately 18%) and cash. The cash position at year-end was about 13%, but we view that as artificially high due to the year-end reallocation of capital between sub-advisors that had yet to be fully deployed; without the reallocation, cash levels remained in the low single digits as a percentage of assets. The portfolio ended the quarter with a calculated duration of 4.2 years and a yield to maturity of 3.8%.

FPA: The FPA Contrarian Opportunity strategy gained 3.0% in the quarter. Top contributors for the quarter were the new Porsche/other-automakers-basket pair trade (owning Porsche and reducing general industry risk by shorting a basket of other auto companies), Mylan, Bank of America, and longtime tech holdings Microsoft and Cisco Systems. The largest detractors were mainly industrials, including General Electric, Esterline, and Meggitt.

The portfolio’s gross long exposure to equities increased again, to 68%, with 23% in foreign stocks (an eight percentage point increase). Net equity exposure increased as well, to 58%. Credit holdings are 6% of assets.

Corporate bonds were reduced, while FPA added a small position in Puerto Rico municipal bonds at deeply distressed prices. Financials remains the largest sector concentration at approximately 21%, with no material changes to the large- and mega-cap banking and insurance names comprising the largest positions. Technology maintains its place as the second-biggest sector exposure, climbing to 13% as FPA added to some top holdings (most notably Alphabet) late in the quarter, following the passage of the tax cut, and established a new position in Expedia. The managers also added to a number of energy positions on the long side, and increased short positions in a small number of companies whose businesses are being disrupted by technology. The portfolio’s large cash position was reduced to 34% due to the additions to the portfolio noted above. While it is encouraging to see the managers find new opportunities worthy of committing capital, the portfolio is still quite conservatively positioned, given the large cash balance, high-quality nature of many holdings, and stub/pair trades, which are less directional in nature.

Loomis Sayles: The Loomis Sayles Absolute-Return Fixed-Income strategy returned 0.9% during the quarter. The strategy benefited from continued equity market strength around the world during the quarter, with equities contributing to performance. Much of the positive impact can be attributed to higher oil prices, which aided energy positions. Additionally, a long call position in a technology name lifted returns after receiving a buyout offer from a rival.

High-yield corporate bonds aided returns as spreads ended the quarter flat, following periods of tightening and widening. Individual energy, electric, and consumer non-cyclical holdings benefited performance the most. Concerns about the impact of tax reform on high-yield companies, the age of the credit cycle, and Federal Reserve policy led to interim volatility, but risk appetite remained strong for most of the quarter. While a decent carry environment persists given the likelihood of tax and economic reforms in the United States, weak year-to-date fund flows may be indicating investor uneasiness.

Securitized assets, particularly CMBS and non-agency RMBS holdings, contributed positively to performance during the quarter as fundamentals remained stable across all sectors. Investor sentiment remained strong as well, with spreads tightening during the quarter. The highly diversified group of bank loans also contributed, with selected capital goods, consumer non-cyclical, and technology names adding the most to performance. The floating-rate nature of bank loans looks attractive relative to many fixed-rate sectors, and investors are also drawn to the relative safety of bank loans given their senior position in the capital structure. The investment team has been reducing exposure to high-yield over the last two years, but the allocation to bank loans remains.

Currency positioning weighed on performance mainly due to the short euro (EUR) position. While performance in the fourth quarter was not as expected, the team remains confident in the valuation driven mean-reversion trades in the portfolio, namely short EUR/Norwegian krone (NOK), EUR/Swedish krona(SEK), and EUR/British pound sterling (GBP). Loomis believes EUR/U.S. dollar is likely to be capped around 1.20, while at the same time NOK, SEK, and GBP offer attractive valuations. Higher oil prices could lift NOK, strong domestic growth and export growth could help SEK (especially if the central bank becomes less dovish), and progress on Brexit negotiations could allow GBP to appreciate. This combination should help these cross-rates to move in a profitable direction for the portfolio over time.

Water Island: The Arbitrage and Event-Driven strategy returned 1.1% in the fourth quarter. Two sleeves of the strategy contributed positively to returns: 36 bps from credit opportunities and 117 bps from equity special situations. The merger-arbitrage sleeve, conversely, detracted from performance (negative 22 bps). (All contribution statistics are gross.)

The top contributor in the portfolio in the fourth quarter was the equity special situations investment in General Cable (BGC). BGC is a global manufacturer and distributor of copper and aluminum wire and cable products with a leading market position in North America. In July 2017, BGC announced a review of strategic alternatives including a potential sale of the company. Having seen consolidation across the industry and noting prior sale rumors around BGC, Water Island viewed the company as a logical fit for Prysmian, its primary European competitor, who had been vocal about doing larger mergers and acquisitions (M&A) transactions and expanding its footprint into North America. Following the announcement of strategic alternatives, Water Island established a core long position in BGC and a definitive acquisition of BGC by Prysmian for $30 per share was announced in December, generating strong returns for the position.

On the flip side, the worst detractor in the portfolio was the merger-arbitrage investment in AT&T’s planned acquisition of Time Warner Cable. In October 2016, AT&T entered into a definitive agreement to acquire Time Warner for $108 billion. The transaction exemplified the shifts occurring in media and telecommunications, and marked AT&T’s desire to add premium content to its strong distribution network. During the quarter, the deal's path to completion hit a roadblock as the U.S. Department of Justice (DOJ) sued to block the merger, citing concerns that it would harm consumers and competition. The news caused the spread to widen significantly, producing losses. The DOJ's lawsuit is an unprecedented departure from past treatment of vertical M&A (where the businesses don't directly compete), and a resolution will likely take four to six months. Water Island continues to maintain the position, believing that AT&T has a strong case, though they have hedged it to mitigate additional losses should the DOJ prevail.

The past year proved interesting for merger arbitrage. Many assumed the new administration would be pro-business and anti-regulation, but such tendencies were not evenly applied. The Committee on Foreign Investment in the United States (CFIUS) provided a fair amount of regulatory interference in U.S.-targeted cross-border transactions, and perhaps most surprisingly, the DOJ sued to block AT&T’s acquisition of Time Warner. Such capricious behavior reinforces the importance of understanding not only the fundamental value of the companies involved in a transaction, but also their businesses, the competitive universe, and the regulatory environment. Water Island does not expect CFIUSintervention to subside and believes there are a number of companies planning large, vertical mergers (particularly in the health care sector) waiting on the sidelines until they see which side prevails in the DOJ/AT&T saga.

Another notable trend was longer regulatory timelines positively impacting certain deals in sectors that rallied significantly. With extended timelines and their peer universes trading up, the risk/reward profile of arbitrage spreads improved due to stronger downside mitigation, allowing arbitrage investors to be more aggressive when warranted. The terms at which deals were originally struck also may no longer have made sense, leading to expectations of topping bids or shareholder activism. (CIBC’s acquisition of PrivateBancorp and Qualcomm’s acquisition of NXP Semiconductor are two notable examples from 2017.) Such situations provided opportunity to generate incremental returns with low risk, a trend that will likely continue as long as the stock market rally persists.

The current spread environment has remained largely unchanged from 2016 and 2017. Given the Federal Reserve (“Fed”) raised interest rates a full 100 bps from December 2016 to December 2017, one might have expected a subsequent widening in merger-arbitrage spreads. That said, the extremely low levels of volatility we witnessed in 2017 have conspired to keep spreads largely unchanged. Unless volatility increases, continued Fed rate hikes may not have a material impact on merger-arbitrage spreads. In equity special situations, re-ratings and transformational M&A situations drove returns for much of the year in the portfolio. Yet in the fourth quarter—following an underwhelming first nine months—speculative M&A situations were the key contributor, likely due to greater clarity on tax reform. Now that business-friendly tax reform has passed, Water Island anticipates improved offers for M&A targets and a healthy volume of speculative situations in the year ahead. They are equally optimistic about M&A-related opportunities in credit going forward, but do not anticipate a meaningful allocation to deep-value situations near term given the extremely low default rates. The credit portfolio remains conservative in positioning, with a short-duration profile to be able to take advantage of the inevitable correction in credit markets.

Strategy Allocations

The fund’s capital is allocated according to its new strategic target allocations: 25% to DoubleLine; 19% each to DCI, Loomis Sayles, and Water Island; and 18% to FPA. We use the fund’s daily cash flows to bring the manager allocations toward their targets when differences in shorter-term relative performance cause divergences.

Sub-Advisor Portfolio Composition as of December 31, 2017
(Exposures may not add up to total due to rounding)

DCI Long-Short Credit Strategy

Bond Portfolio Top Ten Sector Long Exposures as of 12/31/17
Consumer Discretionary 15.2%
Energy 9.8%
Technology 8.1%
Materials 7.3%
Consumer Non-Discretionary 6.6%
Investment Vehicles / REITs 4.9%
General 4.3%
Media 4.3%
Transportation 3.6%
Pharmaceuticals 3.4%


DCI combined CDS + cash bond portfolio gross exposures:
Long 237%
Short -168%


DoubleLine Opportunistic Income Strategy

Sector Exposures as of 12/31/17
Cash 13.6%
Government 1.2%
Agency Inverse Floaters 3.3%
Agency Inverse Interest-Only 3.6%
Agency CMO 7.6%
Agency PO 2.3%
Collateralized Loan Obligations 1.3%
Commercial MBS 1.3%
ABS 5.1%
High-Yield 0.1%
Municipals 1.5%
Non-Agency Residential MBS 59.2%
Total 100.0%


FPA Contrarian Opportunity Strategy

Asset Class Exposures as of 12/31/17
U.S. Stocks 44.5%
Foreign Stocks 25.3%
Bonds 5.9%
Other Asset-Backed 0.5%
Options -0.2%
Limited Partnerships 0.4%
Exchange Traded Funds -0.8%
Short Sales -9.4%
Cash 33.8%
Total 100.0%


Loomis Sayles Absolute-Return Fixed-Income Strategy
Exposures as of 12/31/17

Long Total
Short Total
Net Exposure
Securitized 25.4% -0.7% 24.7%
High-Yield Corporate 10.2% -2.8% 7.5%
Bank Loans 10.0% 0.0% 10.0%
Investment-Grade Corp. 8.7% 0.0% 8.7%
Dividend Equity 9.7% -4.5% 5.2%
Convertibles 3.5% 0.0% 3.5%
Emerging Market 7.9% -3.5% 4.5%
Global Credit 1.4% 0.0% 1.4%
Currency 9.8% -10.2% -0.4%
Risk Management 0.5% -3.3% -2.8%
Global Rates 44.5% -19.4% 25.1%
Cash & Equivalents


Water Island Arbitrage and Event-Driven Strategy
Sub-Strategy Long Exposures as of 12/31/17

Long Short Net
Equity Merger Arbitrage 48.9% -14.4% 34.6%
Equity Special Situations 19.8% -15.6% 4.2%
Credit Opps/Special Sits 11.9% -0.7% 11.2%
Total 80.6% -30.7% 49.9%