Finding Value

As an active manager, our investment strategy involves actively working to find value, rather than tracking a broad underlying index (passive management).  But just what does finding value entail?  We see a couple key areas where we see inefficiencies within the high yield market and where we feel we can find that value.  With our active strategy, we can pick and choose what we want to hold, in what portfolio allocation we want to hold it, and when we want to buy and sell.  We also believe on doing our own credit work and financial assessment of the core, alpha-focused securities in which we invest.

Just like there are popular names in the equity market, we see the same sort of market dynamic in high yield investing.  For instance, there are large, well-covered companies within the high yield sector that often have several tranches of bonds outstanding at any time, which can total billions of dollars in outstanding debt for just one company.  Research from the investment banks and other credit research providers often focuses on the larger issuers within the high yield market.  Smaller credits or companies new to the high yield market (first time bond issuers) tend to have few or even no one covering the security, leaving them “orphaned.”  Some high yield issuers also have public equity, while many do not and are private companies issuing public bonds.  Public bond issuers are required to provide their investors financials but these are not always publicly available as they are for equity issuers.  Getting information can involve tracking down the underwriter or calling the company to get on a private website to get that bondholder information.

Thus, not only does it involve time and energy to analyze the financial and company information, but it can even take time and energy to track down the credit information in the first place.  If an investor or manager is relying on the research put out by the investment banks and credit research providers, they could completely miss these off-the-run names.  Yet through our history we have found value in a number of these overlooked credits.

This certainly doesn’t mean that we are entirely focused on small credits that no one else has ever heard of—we have and do invest in credits across the tranche size spectrum, which includes many $500mm+ tranches.  But we are also open to finding value in areas others aren’t and don’t weight our allocations toward the largest issuers in the high yield market.  For instance, within the index, it is generally the companies that are the largest high yield bond issuers that weigh the most in the indexes (though there is sometimes a cap, such as 2%, of the index).  And with these large issuers weighing on the index, we see the same problem for many of the high yield index-based, passive products tracking the high yield indexes.  Amplify this with the fact that some of the larger passive high yield funds (such as the largest passive high ETFs), have size constraints per the underlying index that eliminate credits with a tranche size under $500mm or $400mm/$1bn in total debt outstanding.  So as these sorts of funds gain a larger share of the high yield bond retail market that can mean less interest in the credits that don’t fit these size parameter, which we believe further creates opportunities for active managers such as Peritus.

Additionally, we find value across the ratings spectrum.  We have learned over our decades of experience to place little credence in the ratings assigned to a credit by the ratings agencies.  Either a credit is “AAA,” and is money good, regularly paying its coupon and paying the investor the par back upon maturity, tender or call, or it is not and it is a “D” credit.  By looking behind the curtain into the company’s business and financials, we determine for ourselves if we believe the credit is money good and if the credit’s yield being offered to us compensates us properly, and invest accordingly.  Just because a credit is rated highly, doesn’t make it an attractive investment.  For instance, the headlines hit in early October that BB credits were trading well through the lowest spreads seen in over a decade.1  These low BB spreads are reflected in the low yields on many of the high yield indexes/sub-indexes with a high BB concentration, and passive strategies that follow these indexes. Yet, there are still many B and CCC credits that we view as money good and offering investors what we would see as attractive, reasonable yields.  As an active manager, we are not forced to invest in less desirable securities either from a very low yield perspective or from a credit concern perspective.

Investors need yield, especially with the low rates currently offered through the rest of the fixed income market (investment grade corporates, Treasuries, munis, etc.) and high valuations on dividend equities.  We believe that our active strategy of finding value without having to take on what we see as excessive risk can work to provide that yield for investors.

1  Jantzen, Nelson, CFA and Peter Acciavatti, “JPM High-Yield and Leverage Loan Morning Intelligence,” J.P. Morgan North American Credit Research, 9/20/17, https://markets.jpmorgan.com.
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