CREATIVITY AND FLEXIBILITY ARE REQUIREMENTS IN A HAWKISH MARKET - JANUARY 2022 NEWSLETTER

“That which is not good for the bee-hive cannot be good for the bees.” –

Marcus Aurelius

• PERFORMANCE – Serenity Alternative Investments Fund I returned -7.25% in January net of fees and expenses. • A PLAYBOOK FOR 2022 – How can a REIT fund make money with the Fed hiking rates?

– LONG GROWTH ACCELERATORS – Growth is still accelerating for certain REITs. – LONG ECONOMIC DECELERATORS – Fed hikes and elevated energy prices will slow the economy. High dividend yield REITs are set to benefit. – SHORT RISK TRIANGULATORS – An active short book is set to generate outsized returns in 2022.

After a year of prodigiously sweet returns in 2021, January 2022 was a stark reminder of how quickly the capital markets can change: Bitcoin down -17%, Netflix down -29%, the Nasdaq down -9%, and REITs down -8%. Some of the best performers of 2020 and 2021 got a cold dose of reality. Anyone that thought the party could never end is feeling the hangover.

The bees buzzing around the US economic beehive are faltering, and for the culprit we need look no further than the US economic beekeeper, the Federal Reserve. With newly found hawkish rhetoric and 40-year highs in inflation readings, the US Federal Reserve is set to increase interest rates as soon as March, while also slowing the growth of, and then potentially shrinking, their balance sheet. What does this mean for investors? In a vacuum, less capital, higher interest rates, and a new headwind for the US economy. The question for investors of all stripes then becomes…how on earth do you make money with a hawkish fed? Per our favorite stoic Roman Emperor, what is not good for the economic beehive (rate hikes) is usually not good for the economic bees (stocks). Creativity and flexibility are requirements at this point in the economic cycle in order to preserve and grow client capital. In REITs, this means narrowing the list of companies we are long to those that can still accelerate their bottom-line growth. It also means looking forward to a slowing economy and getting ready to buy REITs that benefit as growth slows. And lastly, but importantly, it also means embracing the idea of shorting stocks. For companies with high amounts of leverage, high valuations, little profitability, and faltering storylines, a hawkish fed is uniquely dangerous. Add in the probability of a wholesale crash in REIT prices a la 2018, and short bets start to look indispensable. At Serenity we embrace creativity and flexibility. We have narrowed our long book and leaned into the short book early in 2022. Our portfolio is active and ready to pounce on opportunities, but we caution against betting on a white-knight Fed riding to the markets rescue this early into a hiking cycle. As always, we will wait and watch the data, committed to protecting and growing our client capital at all costs.

PERFORMANCE: -7.25% IN JANUARY

Serenity Alternative Investments Fund I returned -7.25% in January net of fees and expenses versus the FTSE NAREIT REIT index which returned -7.93%. On a trailing 3-year basis Serenity Alternatives Fund I has generated annualized returns of +23.2% net of fees and expenses. Over the same time period, the REIT benchmark has returned +12.6% on an annualized basis. The fund’s Sharpe ratio over the past 3 years sits at 1.45, versus 0.70 for the REIT benchmark. $100,000 invested in the fund at the end of 2018 is now worth $210,000; a gain of $110,000 and a 110% return in just over 3 years. The highest positive contribution to the fund’s return in January was Terreno Realty Corp (TRNO). Terreno is a warehouse company focused on owning warehouses that serve the “last mile” of delivery networks. We shorted TRNO at the end of 2021 as a hedge against incredibly strong performance and rich valuations in the Warehouse REITs. The stock fell -12.33% during the month, performing slightly worse than warehouse peers at -8.7%. While we added multiple such hedges at the end of 2021 and took profits in some names, we did not expect volatility in REITs to ramp as quickly as it did in January. A combination of Fed hawkishness and profit taking combined to send some of the best performing REITs of 2022 rapidly lower early this year.

As can be seen from the chart on the right, technology-related REITs (Data Centers and Infrastructure (Cell Towers)) were particularly hard hit in January as the Nasdaq 100 index led the stock market down during the month. Coupled with Warehouses, these sectors sported some of the loftiest valuations in the REIT space going into 2022. Add in their historically higher than average correlation with bonds, and these names were the first teed up for investor sales as Fed hikes came into clearer view.

The worst performing position in the fund in January was Innovative Industrial Properties (IIPR). IIPR has been one of the best performing positions in the fund over the past 3 years and is an illustrative example of what happened in the broader market in January. As IIPR’s valuation got ahead of fundamentals in the back half of 2021, we trimmed our position in the name to just over 1%. This turned out to be prudent, as IIPR fell -24.5% last month. IIPR is a poster child for the recent sell-off. It is a high-growth REIT that traded to an extremely high valuation on optimistic projections. While fundamentals for the name remain strong, this combination of high valuation and speculative growth was severely punished across the market in January. While IIPR is much more interesting 24% lower, it is not clear in the near term what would bring investors back into the name. IIPR is the type of company that thrives when capital is abundant, and speculation is not penalized. With the Fed making a decisively hawkish pivot over the past 2 months, high-flyers may continue to be sold until this hiking cycle concludes. We will wait and watch IIPR for an attractive re-entry point, but with patience. The bottom may still be much lower. THE 2022 PLAYBOOK (LONGS): FINDING GROWTH ACCELERATORS In case it is not clear, we are much more cautious on the REIT market today than we have been since early 2020. Simply put, growth accelerated so quickly and broadly across REITs in 2021, that it will be nearly impossible to comp in 2022. Growth may remain strong in many REIT property types, but when earnings growth falls from 20% to 10% it is almost always a messy transition. Said another way, REITs trading at all-time high valuations on all-time high earnings growth is impossible to replicate. The path of least resistance for growth is lower. That being said, there are pockets of continued strength that bear watching. Coastal Apartment REITs are an example of a subset of the REIT market that still has accelerating fundamentals. Because these names began their recovery AFTER their sunbelt-focused peers, they have a slightly longer runway for fundamental re-acceleration. This is currently playing out as Q4 earnings are reported, with AVB and EQR both guiding to earnings growth in 2022 that is far superior to that of 2021. As always, a picture is worth a thousand words, and the current environment for these names can best be seen in the chart below.

As EQR continues to roll their portfolio rents higher, their same-store NOI growth should continue to accelerate, pushing towards the 10% mark currently being posted by sunbelt names MAA and CPT. While many REITs will see growth slow in the back half of 2022, EQR and AVB may be notable exceptions. We remain long both EQR and select sunbelt Apartments that should continue to post impressive results in 2022.

THE 2022 PLAYBOOK (LONGS) PART 2: FINDING ECONOMIC DECELERATORS

While growth should remain strong for coastal Apartment REITs and some select other REIT sub-sectors, in general it is set to slow meaningfully from 2021’s breakneck pace. This is not only true for REITs, but also for the broader economy. Throw in a hawkish fed and sky-high energy prices, and economic deceleration into 2Q 2022 could be significant. Against a backdrop of slowing economic growth, the selection of “what works” in REITs changes dramatically relative to the growth acceleration of 2021. A decelerating economy is trypically good for lower-growth, higher dividend REITs that offer outsized yeilds. These companies are typically more bond-like, and tend to focus on returning capital to investors, as opposed to re-investing it into growing their portfolio. Historically REITs with lower dividend yields outperform over the full-cycle, but in periods of growth slowing, their higher-yield peers tend to shine.

These REITs have gotten much cheaper relative to peers over the last 18 months as well. Inflation tends to be detrimental to high dividend REITs, and as CPI readings have gone from 0 to 7.0% in 18 months, the REIT rally has left many of these names behind. In October of 2020, a basket of high yield REITs traded at about 11.1x FFO, and now trades at 12.1x FFO. A basket of low-yield REITs previously traded at 23.1x FFO, and now trades at 28.1x FFO.

The valuation difference between these two baskets has gone from 12x to 16x over the course of about a year and half. The yield differential between the baskets is also significant, at 6.6% for 20 high yield names, and only 1.9% for 20 low yield names. This confluence of macro and style factors is extremely interesting. If growth and inflation slow from here (which we believe they will), high-yield REITs look extremely cheap. Additionally, many of these names are Healthcare REITs, some of which may benefit from falling COVID cases and a broader re-opening. In addition high dividend yield stocks with low valuations also provide a margin of safety for names that have well-covered dividends. The addition of some high-yield, inexpensive, bond-like REITs acts as a barbell to our holdings in more expensive REITs with still accelerating growth. In an economy in which growth and inflation start to wane from their 2021 surge, both of these REIT cohorts should theoretically perform well. The final piece of the puzzle in building a rising-rates portfolio then comes in the form of tactial short sales. THE 2022 PLAYBOOK (SHORTS): TRIANGULATING UNWELCOME RISKS Every 18 months or so, the market becomes adverse for REITs. This often happens for reasons independent of the companies themselves, when macro changes or overall market moves spark an increase in volatility. Historically, when the Federal Reserve embarks on a perceived series of rate-hikes REIT’s have underperformed. In order to protect against an aggressive Fed tightening regime, the first place we can look for shorts is in names that have benefitted disproportionately from ultra-accommodative monetary policy. These stocks, in many cases, are “story stocks.” They are companies with valuations that are predicated on unrealistic or extremely optimistic growth assumptions. While these types of companies are more common in the “Tech” and venture capital worlds, they do exist around the edges of the REIT universe as well. And the best way to find them is by using…you guessed it…a quantitative model. In preparing for a potentially adverse environment earlier this year, we designed what is often referred to as a “Torpedo” model for REITs. This model triangulates those characteristics that are most concerning during a fed tightening regime: high valuation, high leverage, high beta, small cap. These are REITs that are likely to be punished by the market disproportionately in the event of a significant sell-off. By shorting a basket of these highly ranked “Torpedo” REITs, we are attempting to hedge the tail risk of an increasingly disorderly sell-off in the REIT space. As we alluded to before, these types of events tend to happen about every 18 months, and as often as not, are triggered by a Federal Reserve policy change. With the Fed set to aggressively tighten policy in the coming months, we believe a certain level of insurance in the form of a basket of torpedo shorts is a prudent portfolio inclusion. FLEXIBILITY AND OPPORTUNITY With the macro environment changing rapidly in 2022 we have put down the rose-colored glasses and are taking a much more circumspect view of the REIT market as we move forward. Fed Policy that is DESIGNED to slow the economy does not tend to lead to higher REIT prices across the board. Succeeding in this new regime requires flexibility and a tactical approach. Luckily at Serenity we have designed our entire business around the concepts of flexibility and opportunism. Our portfolio can make bets in almost any direction, and while we cannot predict the direction of the REIT market, we can insure against highly negative outcomes while maintaining exposure to REITs with strong fundamentals. As always, we will continue to watch the data and dig for new ideas. 2021 was a banner year, but 2022 does not have to be a drag. When the time comes to get bullish again, we will be ready. Mind the beekeeper, Martin D Kollmorgen, CFA CEO and Chief Investment Officer Serenity Alternative Investments Office: (630) 730-5745 MdKollmorgen@SerenityAlts.com

**All charts generated using data from Bloomberg LP, S&P Global, and Serenity Alternative Investments

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