Dupont digs deeper into increasingly illiquid CMBS market

Portfolio manager Karlis Ulmanis sees opportunity in the current environment.

The commercial mortgage-backed securities market is being hit by a period of historic economic disruption, yet Karlis Ulmanis, a portfolio manager at Dupont Investment Management, sees opportunity in the uncertainty.  

“It’s in this type of market where liquidity starts to dry up. This is where I become more active,” Ulmanis said. 

Ulmanis uses proprietary models to identify high-yielding bonds at what he sees as an attractive discount. The potential returns more than outweigh the risk of default due to broader market dislocations, according to Ulmanis. 

“The securities that I buy have large coupons. They have a five, five and a half percent coupon and that helps me to survive extension risk if these properties can’t refinance,” Ulmanis said. 

The bonds Ulmanis is targeting would be able to perform well, even major downgrades, he believes. 

“Lately, I’ve been able to pick up investment grade conduit CMBS deals that are less than two years and with significant equity protection, where I could see the property valuation being discounted by up to like 60 percent and the bond still does not get any losses,” he said. “It’s a big cushion. I built my own models, and I think that’s probably my biggest advantage. It gives me confidence to go to the market and provide liquidity as everybody else starts to bail on these markets.” 

A critical component of his approach is to assess long- and short-term relative value throughout the CMBS sectors he invests in. 

“I differentiate between short- and longer-term risks. I’m long-term negative on retail, I think more and more transactions will go electronic. But in the short term, I think the malls are still good.” 

Fed pullback and recession fears a concern 

Ulmanis does recognize that rising interest rates and a resulting economic slowdown could make CMBS investing more difficult in the coming months. 

“We’re getting higher cap rates, so valuations are going down,” Ulmanis said. “Because of that, a lot of these loans are extending, and they can’t refinance.” 

The Fed’s quantitative tightening should also take out much of the liquidity floating around the commercial real estate market. 

“I think people might be a little bit overreacting. When you hear the word recession, that basically means two quarters of negative growth, but I haven’t heard a lot of people saying that we’re going to contract by 3 or 4 or 5 percent. It might be just a 10th of a percent, you never know,” he said. 

And Ulmanis is glad the Fed is serious about tackling inflation. 

“I think that’s a good sign that the Fed is trying to nip this in the bud sooner than later,” he said.

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