Rational Funds has launched the Rational Special Situations Income Fund (RFXIX), which utilises an investment strategy primarily focused on non-agency residential mortgage backed securities. The fund, which originally launched as a hedge fund in 2009 and was converted into a mutual fund by Rational Funds, retains the same strategy and management team and has an average annualised return of over 16 per cent since inception. The fund’s investment objective is total return consisting of capital appreciation and income.RFXIX, which is Rational Funds’ third hedge fund conversion, invests primarily in pre-2008 non-agency residential mortgage backed securities (NARMBS) which have more predictable collateral performance given the underlying loans’ significant age. Typically, investments are in senior tranches and floating rate bonds, therefore minimising interest rate risk. The Fund is sub-advised by ESM Management LLC.The fund’s performance has generated in excess of 14 per cent alpha over a decade compared to the Bloomberg Barclays US Aggregate Bond Index. Focused on identifying underpriced securities using independent credit and modelling work, the investment team also looks for structural flaws in the construction of NARMBS and other asset-backed securities. Returns are enhanced by identifying and correcting bonds in which payments are being handled incorrectly or governing documents are being misinterpreted. In some cases, litigation is used in order to rectify issues.“As we continue to identify opportunities to bring unique strategies from the hedge fund world to the mutual fund space, this particular investment strategy caught our attention because of its highly specialised approach to fixed income and its unusually strong performance record for 10 years running,” says Jerry Szilagyi (pictured), CEO of Rational Funds. “The team at ESM Management has developed a unique expertise in the non-agency mortgage backed security space, and we believe that expertise, now offered via the Rational Special Situations Income Fund, presents a desirable alternative and proven approach to fixed income investing.”Eric S.Meyer, PhD, founder of ESM Management and RFXIX’s hedge fund predecessor, remains portfolio manager, along with co-portfolio manager William R Van de Water. Together, Meyer and Van de Water have over 30 years’ experience in the fixed income world. Both previously worked at Susquehanna International Group, and both began trading and investing in mortgage backed securities in 2005.“Over the last decade, we have focused on finding mis-priced securities in the pre-recession, USD800 billion NARBMS space,” says Meyer. “These securities are structurally complex, and flaws in the drafting documents or in standard modelling software often go unnoticed by market participants. Our strategy limits generalised credit and interest rate risk and targets idiosyncratic risk, and this approach reduces correlation to traditional fixed income and equities markets. We have developed expertise in quickly identifying the key drivers of a complex security’s value and in unlocking that value. Occasionally this involves taking an activist approach, including threatening, or carrying out, litigation.” The Rational Special Situations Income Fund trades under the tickers RFXIX, RFXAX and RFXCX.