Hello and welcome to CEF Insights, your source for closed-end fund education and perspectives. I’d like to thank you for joining us as Calamos Investments leaders discuss their alternative equity strategy outlook. To begin, I’d like to introduce Robert Bush, Jr. Senior Vice President and Director of Closed-End Fund Products, who will lead the discussion with Michael Grant, Co-CIO, Head of Long/Short Strategies and Senior Co-Portfolio Manager. Thank you both for joining us.
Robert Bush, Jr.:
Thank you. And on behalf of Calamos, we welcome the opportunity here to talk with CEFA and certainly with the perspective shareholders. Again, Michael Grant is joining us today. He’s the Portfolio Manager of the Calamos Long/Short Equity and Dynamic Income Trust (CPZ). Michael also is Head of our Long/Short Strategy here at Calamos Investments. So, Michael, thanks for joining us today. I’m going to lead in with a couple of questions which I think will be helpful as our clients better understand the product, and I think it’s a great lead in into what your thoughts are in managing the product and what you see today and perhaps in the future. So, Michael, CPZ is a unique dynamic closed-end fund that invests in both long/short equity as well as income producing securities such as high yield bonds and preferred stocks. In fact, it’s the only closed-end fund that actually has an investment thesis of investing in long/short equity strategy. How is the portfolio adjusted to accommodate changes in interest rates and the environment for equities given its dynamic structure?
Sure. Well, first I’d like to thank everyone for their time today. CPZ was launched back in late 2019. And it was a very interesting moment for the financial industry because we were right in the midst of the free money era and interest rates were at levels that had often never been seen before, certainly the lowest levels in more than a century. As most of you know, the closed-end market is an income market. Clients buy closed-end funds because they have a need for income. One of the real conundrums of that moment back in 2019 was that much of the financial landscape did not offer income. That didn’t mean there wasn’t a need for it, it meant that the search for income was not just fruitless but possibly quite dangerous if we left the era of free money behind. And therefore, CPZ’s mandate was to deliver the income but use the equity world or the equity part of the capital structure rather than the traditional fixed income part of the capital structure.
We felt that was a safer place to search for income. And we also constructed the fund to ensure we had the flexibility to move across the capital structure depending upon how this long era of free money evolved. Now, the fund has delivered an annualized yield since inception of just under 10% and none of that yield has been a return of capital. So, the product has been remarkably successful in delivering on its promise. And notably, of course, since the launch of the fund four years ago, we have left the era of free money behind. I’d like to show you a chart of real interest rates and the real 10-year yield in particular over the last three decades.
Real Long Rates Signal Another Shift of the Investment Regime
And you can see that in the ’90s and then again in the first 10 years of this century and then in the post-2008 era, we constantly shifted downward in interest rates and therefore clients had to go further and further out on the risk spectrum to achieve their yield.
And we believe that era has ended. And if you look at this chart, we launched the fund, CPZ, almost at the nadir of this slide and we were highly conscious of the risk of that post 2008 era shifting back to a more normalized interest rate world. And that’s exactly what has happened.
Most of the industry over the last five years, of course was seeking yield in fixed income markets and that’s been a disaster. Bonds have materially underperformed relative to equities. The US 10-Year Yield, for example, in capital terms has declined about 50%. So, the structure of the fund, the strategy of the fund, it was very well-timed. And given this new era that we seem to be progressing towards, I think it continues to be very well-placed to give clients that income that they need without the risk.
Robert Bush, Jr.:
Well, you make an excellent point, Michael, and then as we know, the primary picture of the product is this long/short strategy which allows us to manage the equity exposure. And you’ve done quite well with that. Actually, you’ve raised the distribution rate on this fund, not once, not twice, but three times in the last nearly four years. That’s 27%. And that’s in an environment that’s had an enormous amount of volatility both in the stock and bond markets. So, preservation of capital, which is important in a way to manage that distribution is critical. And that’s what this fund allows us to do and that’s why these distributions have been so compelling. Because, again, many funds over the course of the last, call it year or so, have actually had to cut their distributions or source return of capital. This fund has not had to do that.
And again, it’s about the preservation of capital, it allows this fund to do many things other funds haven’t during this period of time. Michael, year to date, through September, again, on that point, the NAV returns to the portfolio have held up well relative to both global equities and fixed income indices while subjecting the portfolio to limited market risk, all while earning a monthly distribution rate on a price that as of last Friday, the 20th of October, was above 12%. Could you elaborate a bit on how you’ve been successful in managing the volatility in both the equity and the fixed income markets?
Sure. So, one of the key features of this mandate is its flexibility to move across the capital structure of a company. So, most of our industry is segregated. You’re an equity buyer or a fixed income buyer or you’re high yield credit versus preferred. This fund is different, first, because of our ability to move across the capital structure. If the yield opportunity is in equities, we can go there, if it’s in high yield credit, we can go there. So that’s one key source of flexibility. The other key source of flexibility is expressed by the long/short portfolio where we have the ability to invest in equities when we’re properly paid to invest in equities, i.e, risk adjusted, we lean into equities. On the other hand, we have the ability to completely hedge ourselves and take that risk off the table. And that’s another very unusual source of flexibility in our mandate that you don’t have in traditional equity mandates.
CPZ: A Powerful combination of hedged equity exposure and monthly distributions
And then the final point is that most clients benchmark passively to major indices and those industries, again tend to be segregated by country. So, they have a US allocation versus an international allocation or versus an emerging market allocation. Our product is truly global, so we can go wherever that yield opportunity is. If we’re properly paid in dividends to buy a UK bank versus a US bank, then we can go to the UK bank. If we’re properly paid for yield by investing in a Mexican REIT rather than a US REIT, we will go and invest in that Mexican REIT. And we can do it not just for the long portfolio, but we can also hedge ourselves that way as well on the short side. So, the mandate is fundamentally an active mandate and we believe that an active approach will become absolutely decisive if our view that financial prices are going to be much more cyclical in the coming decade than they were in the post-2008 decade. And I think advisors need to think about the importance of having an active component in their client portfolios.
Robert Bush, Jr.:
That’s an excellent point considering the volatility we’ve experienced this year and which we may experience going forward. One of the things I’d like to talk about is the idea of a recession. Again, I think many minds are back and forth on that. You made the call, which I think at this point is absolutely correct, over the course of the last year that the US was not headed into recession and you structured the portfolio accordingly to the benefit of our shareholders. Do you still hold that view at this point in time?
So, we have been adamant that recession risk was remarkably low in 2023. Now beginning in July, we’ve seen an impressive rise in real interest rates and investors have a gathering sense that this change in the interest rate landscape is flagging another more material change in the overall economic outlook. And I think that’s quite possibly true. The consensus looked for recession in 2023, they were wrong, so they’ve simply shifted the recession forecast into 2024. One of the key debates today revolves around the underlying resilience of the US economy. My view is that recession risk has not just been low this year, it may well remain low through 2024. And a recession deferred may be why the equity correction has been orderly despite all the headwinds we’ve seen this year. The spring banking crisis, the housing recession, the acute pause in technology spending.
Put another way, yields are rising because they can and they may signal the sustainability of today’s economic expansion. Rather than fueling waves of asset price distortion, which is what happened post 2008, positive real interest rates channel capital into productive uses, they channel capital to higher real wages and higher real returns. And that’s why we should look at this change in the environment as fundamental. Unsurprisingly, unwinding the legacy of naturally low interest rates is a transition and there’s risk in that transition and markets are in the midst of trying to price that risk. Nonetheless, I think the key shift relates to the resiliency of the US economic outlook and of consumer incomes in particular, at least through the first half of 2024.
Robert Bush, Jr.:
Very interesting. Lastly, of course, many advisors out there, they’re still asking the question as to where do we go from here? We’ve seen back and forth here in 2023, is the Fed finished? Are they not? You talked a little bit about recession. Are interest rates going to continue to rise? Is the 10-Year at 5% the new norm? What are your thoughts going forward towards the end of 2023 and into 2024 and how do you expect to position the portfolio accordingly?
So, one of the very unusual features of today’s landscape is that there is an absence of what we would call late cycle excesses. Late cycle excesses would normally be the ingredients for a cyclical downturn. And historically, those types of excesses would include too much spending in the housing and auto sector, it might include increased leverage by households and corporates, it would certainly include a deterioration in profitability for the corporate sector. We’re not seeing any of that today.
US Households: Less Interest Rate Sensitive
In fact, many parts of the economy look much earlier cycle than end of cycle. Now that said … And by the way, the evidence of this can be seen in household balance sheets, in corporate balance sheets and so forth.
Now that doesn’t mean that there aren’t parts of the economy under extreme stress at the moment because of higher interest rates. And what’s happened in markets, both in bond markets and equity markets since July, is that these stresses in particular parts of the economy have become more acute. And I think we’re near the moment when interest rates need to stabilize to ease those pressures. Our view is that the US 10-Year Yield’s peak for this cycle is probably close to 5% and we’re almost there. And if we’re correct about that, we should see a slowing economy into early 2024 and the pressures come off the interest rate side in a manner that allows some easing of financial conditions. So, there is a window for a trading rally in the S&P 500 into spring, with modest upside. By modest, I’d say 4,500, for example, on the S&P 500.
The important message, however, is that a US 10-Year Yield of 5% may be the appropriate normalized interest rate for the economy in this new normal and that changes many features of our industry. One of the key shifts is that financial asset prices will be much more cyclical in the coming decade. Both equities, we think equities will be in a very broad trading range for years to come, but also for bonds. If a 5% yield is a normalized yield, there’s a pretty good chance in coming cycles that we’ll test both the upside and downside of those boundaries. In other words, we could see a 6% 10-year yield sometime in the next two years and we could test the limits on the downside of 4%. And all this comes back to the need for investors to be far more active in how they allocate capital for their clients. And that active character is a key feature of this product, CPZ, and that’s why we think it’s a perfectly appropriate vehicle for you to earn high levels of income carefully managed for the kind of new era that we’re heading into.
Robert Bush, Jr.:
You’re quite right. That dynamic asset allocation strategy is critical, again, particularly in preserving capital during downturns, which we saw last year, which has allowed this portfolio to not just maintain but increase its distribution 27% since inception. Michael, thank you so much today for your time and your thoughts. Again, we’re talking to Michael Grant, who is the Portfolio Manager for the Calamos Long/Short Equity and Dynamic Income Trust, ticker CPZ. He’s also Co-CIO and manages the long/short strategy here at Calamos. So again, thank you for your time and CEFA thank you for the opportunity to have us share our thoughts with our clients and prospects of this fund.
Thank you, Robert and Michael. And thank you to our viewers for joining another episode of CEF Insights. For more CEF Insights videos and podcast episodes, visit Closed End Fund Association – Closed-End Fund Association, your independent source for closed-end fund education data and perspectives. Thank you.
Past performance is no guarantee of future results.
Diversification and asset allocation do not guarantee a profit or protect against a loss. Alternative strategies entail added risks and may not be appropriate for all investors. Indexes are unmanaged, not available for direct investment and do not include fees and expenses.
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Investments by the Fund in lower-rated securities involve substantial risk of loss and present greater risks than investments in higher-rated securities, including less liquidity and increased price sensitivity to changing interest rates and to a deteriorating economic environment.
Fixed Income Risk. Fixed-income securities are subject to interest rate risk; as interest rates go up, the value of debt securities in the Fund’s portfolio generally will decline.
Convertible securities risk. The value of a convertible security is influenced by changes in interest rates, with investment value declining as interest rates increase and increasing as interest rates decline. The credit standing of the issuer and other factors also, may have an effect on the convertible security’s investment value.
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Limited Term Risk. Unless the limited term provision of the Fund’s Declaration of Trust is amended by shareholders in accordance with the Declaration of Trust, or unless the Fund completes the Eligible Tender Offer and converts to perpetual existence, the Fund will dissolve on the Dissolution Date. The Fund is not a so called “target date” or “life cycle” fund whose asset allocation becomes more conservative over time as its target date, often associated with retirement, approaches. In addition, the Fund is not a “target term” fund whose investment objective is to return its original NAV on the Dissolution Date. The Fund’s investment objective and policies are not designed to seek to return to investors that purchase Shares in this offering their initial investment of $20.00 per Share on the Dissolution Date or in the Eligible Tender Offer, and such investors and investors that purchase Shares after the completion of this offering may receive more or less than their original investment upon dissolution or in the Eligible Tender Offer.
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As of 10/31/2023.
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