Josh Tarnow: Alternative bond strategy for low rates, high volatility

As the appetite for alternative investment strategies has expanded in the wake of the 2008 financial crisis, it could be argued that some fund companies and portfolio managers have stretched the limits of their abilities to manage alternative products.

That isn’t the case with Josh Tarnow, 45, manager of the BlackRock Global Long/Short Credit Fund (BGCAX).

Not only is he well-qualified to manage this kind of alternative fixed-income strategy, he also possesses the unique ability of being able to explain it in relatively plain English.

“We wanted to create a fund to address two things: a low-interest-rate environment and volatile credit spreads,” Mr. Tarnow said. “We felt the best way to capture alpha, as well as beta, was to employ a long-short strategy.”

The fund was launched in late 2011 and was designed to give Mr. Tarnow and the rest of his team ample flexibility to move throughout the $11 trillion global credit environment. Its assets have doubled since the start of the year to more than $830 million.

“The market was very skittish at the time we launched this fund,” he said. “For the past 20 years, over 80% of fixed-income returns were driven by duration and playing the right side of rates, but in this low-rate environment, it would be hard to rely on rates for performance.”

Mr. Tarnow is a managing director and member of the corporate-credit group within BlackRock Inc.’s fundamental-fixed-income unit. He came to BlackRock in 2009 as part of the acquisition of R3 Capital Management LP, a $2.3 billion general-credit hedge fund where he was a senior partner.

R3 Capital was originally part of Lehman Brothers Holdings Inc. but was spun out in 2008. Mr. Tarnow started working for Lehman Brothers in 1992 as a corporate-bond trader.

Morningstar Inc. puts the BlackRock Global Long/Short Credit Fund in the nontraditional-bond category — a category that was created in 2009 to address the growth of funds with more-flexible fixed-income strategies.

Since the start of the year, the fund has gained 130 basis points, which compares with a gain of 94 basis points for the nontraditional-bond category and a decline of 27 basis points for the Barclays U.S. Aggregate Bond Index.

“It is pretty novel to see a bond fund that is shorting, as opposed to just shortening duration,” said Todd Rosenbluth, a fund analyst at S&P Capital IQ.

“It is a hedge fund style,” he said. “And it’s a strategy that seems to have worked in the short time that it has been out there.”

Mr. Tarnow acknowledges that short selling isn’t instinctive, particularly in a bond fund.

“It takes a different mindset to short a security, because we’re conditioned to look for positives, but this is what I’ve done my entire career,” he said. “We didn’t want to create a strategy that was just appropriate for that time we created it, so we created something that is wholly sustainable for any market.”

FOREIGN EXPOSURE

The fund holds more than 200 positions and is mandated to have at least 30% of the exposure outside the United States, which hasn’t been a problem. As recently as last summer, the fund was split evenly between U.S. and non-U.S. exposure.

The most recent report shows the fund with a 70% allocation to non-U.S. securities.

That report also shows the fund positioned at 98% long and 54% short, for a net-long exposure of 44%.

But Mr. Tarnow, who views the world like a true long-short manager, prefers to add the long and short exposures to describe the portfolio as 152% exposed to the market.

“It’s a whole lot of fun, and this has been the perfect environment for this product,” he said. “We’re not asking anyone to love high yield or investment-grade, or to hate high yield or investment-grade — we’re just trying to find out ways to make money in the credit markets.”

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