Alternatives U.S. Liquidity Relative Value

Investment Objective

PGIM Fixed Income’s U.S. Liquidity Relative Value Strategy is a market-neutral, non-credit strategy investing in liquid sectors of the US fixed income market. The Strategy seeks to maximize returns relative to ICE BofAML 3-Month LIBOR by utilizing multiple relative value strategies and investing primarily in long and short positions in U.S. government and agency securities and mortgage-backed securities issued or guaranteed by U.S. government sponsored enterprises or agencies, as well as derivatives on the foregoing.1

1 There is no guarantee that these objectives will be met.

Investment Philosophy

The U.S. Liquidity Relative Value Strategy’s Relative Value platform is predicated on the belief that there are both persistent structural inefficiencies as well as near term dislocations in the liquid and securitized sectors of the U.S. fixed income market. In our experience, different markets are characterized by different structural inefficiencies, some for long periods of time. The proprietary quantitative models we use in the Strategy are expressly designed to identify and capitalize on such inefficiencies. The Senior Portfolio Managers expect that the Strategy will, in the aggregate, exhibit little correlation to the broad equity or fixed income indices.

Investment Process

The U.S. Liquidity Relative Value Strategy currently implements six different trading Sub-Strategies, with three of those Sub-Strategies considered “strategic” allocations and the other three used “opportunistically”. The three “strategic” allocations—the Treasury Optimal, Treasury Relative Value, and MBS Relative Value Sub-Strategies—combined have a current target weight of approximately 70% of a portfolio. The other three—Swap Relative Value, Futures Relative Value, and Spread Trading—are used more opportunistically, and have a current target weight of 30% of a portfolio. Please note that these are “target” weights only and are not hard-and-fast maximums or minimums. Actual portfolio weights may differ materially from target weights in different market environments.

 
Sub-Strategy Pro-Forma Strategy Allocations Decscriptions
Treasury Optimal Total: 20% Seeks to maximize fundamental value in U.S. Treasuries using proprietary quantitative models
TreasuryRelative Value Total: 20% Seeks relative value along the U.S. Treasury curve using proprietary quantitative models, along with portfolio manager input
MBS Relative Value Total: 5% Seeks relative value in U.S. mortgages using proprietary quantitative models, along with portfolio manager input
Swap Relative Value Total: 10% Seeks relative value in the swaps and Eurodollar markets using proprietary quantitative LIBOR curve model
Futures Relative Value Total: 30% Seeks arbitrage opportunities between futures and Treasury markets
Spread Trading Total: 15% Seeks relative value spread opportunities between LIBOR, Treasuries, agencies, and mortgage-backed securities

With these target weights as a guide, the Senior Portfolio managers continually seek to construct a diversified mix of these strategies to maximize the ex-ante information ratio of an overall portfolio while managing systemic risks. They continually evaluate the opportunity set within each Sub-Strategy and adjust weights accordingly.

The Senior Portfolio Managers, as well as the sector managers who work with them, seek to identify relative value opportunities using PGIM Fixed Income’s proprietary quantitative analytics, as well as their seasoned qualitative judgment and trading expertise.

Each opportunity is evaluated by the Senior Portfolio Managers based on its expected unit of return per unit of volatility, net of transactions costs. If the expected return from convergence is greater than the expected volatility, the Portfolio Manager will implement the trade. Specifically, the Portfolio Manager will establish a long position in the “cheap” security and short the “rich” security, while simultaneously taking opposite positions in the financing markets. PGIM Fixed Income incorporates a variety of these types of trades within each Sub-Strategy, seeking at all times to maximize the overall expected information ratio of the overall portfolio while remaining within the constraints established by the risk budget used by PGIM Fixed Income in connection with the management of the Strategy.

The risk budget is the starting point for portfolio construction. Each sector manager then assesses prevailing relative value opportunities in his sector, mindful of the amount of risk he is able to “spend” in the sector or strategy. Each sector manager then raises his best relative value ideas to the Senior Portfolio Managers, who collectively assess all of the ideas from all sectors together. In making their assessment, the Senior Portfolio Managers consider existing positions in a portfolio, existing risk exposures, the risk budget and how it is currently filled, and market, trading, and liquidity considerations.

Senior Portfolio Managers

 

Erik Schiller

CFA, Managing Director and Head of Liquidity