The focus of our investment process for our core credit holdings is on the future prospects of the business we are effectively lending money to. As we look for prospective core, alpha generating investments, we often target companies that possess some or all of the following characteristics:
- Companies that have a product or service that is considered “essential” or recurring;
- Hard asset values that provide some support for the company’s value;
- A manageable capital structure;
- A stable revenue stream and/or an adjustable cost structure;
- A company or industry that is out of favor for the wrong or temporary reasons;
- Excess liquidity
Furthermore, a primary area of consideration is the future free cash flow generating ability of the businesses we invest in. Our belief is that a business that can generate a true economic profit after expenditures (free cash flow) may create a margin of safety for our investment. This free cash flow is not the popular “EBITDA” or earnings before interest, taxes, depreciation and amortization; rather, free cash flow is defined as cash from operating activities less capital expenditures. While this process by itself is reasonably common among active credit managers, the key for us is in identifying what we see as undervalued securities which have a low price to expectations and may provide more attractive yields than provided by the indexes that represent these asset classes.
Once we have identified a prospective core credit investment, we begin our credit analysis.
- Financial Analysis: We typically begin by looking at the company’s three major financial statements—the income statement, the balance sheet and the statement of cash flows—primarily focusing on the company’s ability to generate cash flow (statement of cash flows) and the company’s liquidity and capital structure sustainability (balance sheet).
- Combined Approach: In our investment analysis, we combine both “top-down analysis,” looking at the larger economic and industry dynamics, with “bottom-up” analysis that involves a review and analysis of the company’s financial information, which can include quarterly earnings conference calls, investor presentations, financial filings, and other relevant documents. This process can entail identifying the relevant risk factors and assessing the company’s ability to withstand these factors.
- Valuation Analysis: Peritus does not stop with traditional credit analysis that focuses on business fundamentals, but may also undertake an appraisal of the company’s intrinsic value, assessing whether they view a security as over, fairly, or undervalued.
- Capital Structure Analysis: Through our fundamental and valuation analysis, we not only determine whether an investment should be made in a certain company, but also where in the capital structure (secured, senior, or subordinate) we believe the risk/return is most attractive.
- Trading Input: Additionally, our traders are engaged in the security selection process, working in conjunction with the analysts to effectively combine our expertise in market technicals with credit fundamentals. Because much of what we do is not an “exchange traded” asset class, the ability to find, negotiate, and acquire high yield bonds and floating rate loans is a critical component to execution.
Once a core credit is approved and purchased, we continue to monitor the individual names and the portfolio daily.
While our portfolio strategy focuses on these core credit holdings, in which our goal is to generate attractive income and alpha for investors, we supplement those holdings with a strategic allocation to newly issued high yield bonds. The process for investing in newly issued bonds has a focus on market technicals, as we pay close attention to pricing terms and investor demand. We complement the market technical focus with a review of company fundamentals, via roadshow presentations or offering memorandums. The newly issued bonds have a much shorter-term target holding period, generally ranging about 90-120 days, while our core credit holdings have longer-term target holding period as we look to extract value from the security, and the new issue portion of the portfolio has tight sell triggers. The goal of including newly issued bonds as a strategy enhancement is that we see it as a way to work to improve liquidity and dampen volatility for the strategy as a whole.
Peritus’ primary goal is to hold an actively managed, diversified basket of securities that generates what we see as attractive tangible yield to the investor and allows for potential capital appreciation. Our preference is to hold approximately 70-100 securities in our portfolios, which we believe accomplishes our goals.