Morningstar - Q1 2023 - 47

Fund Size
0.81
Net Flows
-0.05
-2.5
EXHIBIT 2 05/2015
lower-rated issues, including those created after
2008 and their many spinoffs.1
The Garrison
Point team saw this as an opportunity to swoop in
on unloved securities and devoted AlphaCentric
Income to subprime nonagency RMBS.
But that's not all. Within lower-quality nonagency
RMBS, AlphaCentric Income preferred " odd lots. "
Like a standard carton of 12 eggs, bonds tend
to trade in " round lots " that at par cost $1 million
each (1,000 bonds at a face value of $1,000 each).
But just as a grocer would discount the price
per egg of a carton containing only seven eggs to
get a customer to purchase it, dealers holding odd
bond lots regularly discount their per-bond
price to move them. AlphaCentric Income liked
these kinds of discounts and often bought them.
The bonds that sparked AlphaCentric Income's
interest also were not widely held. The percentage
of securities in its portfolio that it alone owned,
according to Morningstar's extensive database of
public funds, typically exceeded 50%, and
exceeded 86% in June 2022 ( EXHIBIT 2 ).
Alongside its proclivity to buy subprime, odd-lot
nonagency RMBS, this feature of limited to
unique ownership made many of AlphaCentric
Income's holdings difficult to sell. Widely
held bonds can more easily flow from seller to
buyer without lowering the price much. That's
because if a fund already owns them, the
due diligence has already been done. In contrast,
if no one else owns a bond and you need to
sell it, the potential buyer must take time
to evaluate the security and may be turned away
by its novelty if nothing else. Hastening the
sale of such bonds often requires offering them
at a discount big enough to nudge the buyer
to look past that novelty and any uncertainties.
AlphaCentric's Fall
As one of the most aggressive mortgage funds
that Morningstar tracks, AlphaCentric Income
soared past its competition when credit markets
05/2017
05/2019
11/2022
Sole Owners AlphaCentric Income's bonds were not widely held by other funds.
In June 2022, 86.8% of its holdings were solely owned by the fund.
Number of Owners of the Securities Held by AlphaCentric Income Opportunities
100
50
75
25
-25
03/2019
12/2019
Source: Morningstar Direct. Data as of June 30, 2022.
09/2019
06/2019
06/2022
1
2 to 5
6 to 10
11 to 20
21 to 50
More Than 50
NA
Number
of Owners
boomed from mid-2015 to 2019. In retrospect,
though, even in those years the pressure to
perform seems to have led to cutting corners.
In its first few months, when it was relatively
small, the prices of AlphaCentric Income's
odd-lot bonds were marked up to the higher
prices of round-lot bonds immediately after
purchase. That overstated its net asset value, or
fund share price, by more than 7%. At least,
that's according to an SEC case that was settled
on June 3, 2022.
That wasn't the SEC's only charge. It also found
that from January 2017 into February 2019,
the fund's team submitted bids to broker/dealers
offering to purchase bonds it already owned
at prices higher than those used by the third-party
pricing vendor. In some cases, the fund held the
entire bond and couldn't buy more. This caused
the pricing vendor to raise its marks to match
those bids, artificially increasing the fund's NAV.
As a result of these two charges, the SEC censured
the fund's advisor, AlphaCentric, and fined it
$300,000. It did the same to subadvisor Garrison
Point, imposing a steeper $3.5 million penalty.
Those SEC charges also presaged AlphaCentric
Income's recent troubles. They showed
just how little trading activity there is in many of
its securities and how their prices, when
they do adjust, do so not incrementally but
dramatically. The same dynamics that helped in
past rallies have hurt in this year's selloff.
Between poor performance and massive
outflows, the fund's asset base was down more
than 80% in 2022. Difficulties multiplied in the
days immediately after Russia's Feb. 24 invasion of
Ukraine, when investors redeemed more than
$1 billion of the fund's assets. That would have
inclined the Garrison Point team to sell the
fund's most liquid holdings first. At the start of
2022, its cash, exchanged-traded holdings,
1 The nonagency RMBS market is one of the most fragmented within fixed income. A broad division can be drawn between legacy securities-those issued before 2008 and found at the
heart of the financial crisis-and so-called 2.0 securities, issued after 2008. Nested within each division are multiple (and growing) subdivisions, and across the full spectrum there are further
delineations by tranche and credit rating. The result is a disparate market where both risk and opportunity lurk. It serves as a natural playground for savvy active bond managers as well
as their imprudent counterparts, but even among the professionals, few possess the skills and tools to thoroughly track and analyze the whole nonagency RMBS market. Thus, most focus
either on legacy or 2.0 securities, or just one or two subsectors within them.
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Percentage of Securities

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