Much attention has been drawn to the lack of liquidity in fixed income markets over the past six months. One of the areas of specific focus has been the high yield exchange traded fund (ETF) space. There is no question that the full implementation of the Volcker provision inside Dodd-Frank and further bank regulation known as the Basel Accord (Basel 2.5 and 3 in this case) has reduced market making in non-investment grade bonds and loans. These concerns have garnered a great deal of media attention and unfortunately caused some investors to flee the asset class in a panic. This is both unfortunate and, in our opinion, the wrong thing to do, especially at this time. The fact is, we have rarely seen a larger liquidity premium (bonds trading at big discounts to call or maturity prices) being paid to investors and we encourage them to take advantage of it. We are adjusting our own portfolio to address some of these liquidity concerns. Click here to read more on our market thoughts and strategy.
Accurately calling interest rate moves has proved to be a difficult task for investors over the past few years. As we entered 2014, virtually everyone (except ourselves) expected rates to rise as the long awaited “taper” began. Yet, the opposite played out over the year with the 10-year Treasury rate falling nearly 75bps, only to fall further in the beginning of 2015 and subsequently bounce back over the last month. The only aspect of rates that can be accurately predicted is volatility. While we are not convinced that a rapid rise in rates is on the horizon, for the sake of argument, let’s assume that rates do rise from here. What does that mean for the high yield bond market and the various “strategies” out there to deal with rising rates? Historically speaking, the high yield bond market has performed well in a rising rate environment. Click here to read our recent piece “Strategies for Investing in a Rising Rate Environment.”
“Markets can remain irrational longer than you can remain solvent,” John Maynard Keynes
We would think if Mr. Keynes was alive today, he would certainly apply his famous quote to today’s oil markets. After collapsing almost 50% during the last half of 2014, oil continued to fall into the mid $40s during the first quarter of 2015 and many pundits are calling for further declines. Oil collapsing by 60% because of a temporary 2% over supply certainly seems irrational to us. Rather, our take is that supply-demand fundamentals will re-assert themselves aggressively by the fourth quarter of this year. This does not mean that prices will react immediately. It is likely that broken market psychology will take at least another quarter or two to react.
The energy industry and its various sub-sets remain one of the most interesting and attractive areas for long term fixed income investors. The current stress provides an excellent entry point, but also many traps in the way of companies that we do not believe will survive the current environment. Caution and selectivity is critical, as investors need to understand the underlying fundamentals, including hedging, cost structure, and capital needs to sustain production of each company in which they invest. We believe active management is essential as investors take positions not only in energy-specific names, but in the general high yield market, since energy is such a large component of the space. Click here to read our full piece, “Irrational Oil Markets.”
With oil prices cut in half over the last six months, here is a quick look at where we have been, the supply situation, and where we are going. Click here to view.
The concurrent storms in energy and the secondary bond/loan markets have tested our mettle. However, we believe that both of these will pass as quickly as they came, but provide fantastic entry points for thoughtful investors as there is a hard cold reality every investor is facing: interest rates (yields) remain paltry and we expect will continue to for the foreseeable future. We ultimately expect the underlying fundamentals in certain segments of the energy sector will be realized and now are seeing yields and discounts (to par) in the broader high yield market that we have not seen for some time. This compares to an equity market where we expect valuations to struggle to move higher in a world of slowing growth. For more on our thoughts about financial markets and outlook, click here to see our latest piece, “Rome is Burning.”
Markets are funny beasts. Efficient? Perhaps. Manic? Always. What has been going on since everyone came back from the beach is quite simple: risk off. There has been a quiet but vicious downdraft in both credit and small cap equities which has really been hidden by those following the Dow and the S&P 500. As high yield bond spreads have widened dramatically over the last month to levels not seen in over a year, we believe this provides an attractive entry point into high yield corporate debt. To see our full commentary on current market conditions and how we are investing accordingly, click here.
Access to and pricing of energy in all forms matter immensely to consumers, markets and economies. Prices of electricity, gasoline, diesel and jet fuel are directly affected by oil prices and impact all consumers. We have seen the pricing on near month WTI oil futures contracts fall over the last month and during the past year. So does this have any real impact on our portfolios and does it change our thesis of higher oil prices in the future? Click here to see our update on the energy market.
At Peritus we run actively managed portfolios of high yield debt. Our primary goal is to provide investors with a high current income, as well as the potential for capital appreciation. In addition to investing in the high yield bond market, we also look to the floating rate loan market and the equity market as we seek to generate this tangible yield for investors. Click here to read our “Investor’s Manual,” where we discuss our investment philosophy and current opportunities we see in today’s market.
We ended 2013 with virtually everyone (except us) expecting rates to rise in the year ahead as the long awaited “taper” began. Well, so far in 2014 we certainly have not seen any rate pressure materialize as the Fed slowly decreases their asset purchases. With unemployment and underemployment still elevated, very moderate global growth, demographic headwinds, and the Fed explicitly clear in extending their low interest rate policy for a “considerable time” once their asset purchases have been eliminated presumably by the fall of this year, it is unclear that a rapid rise in rates is on the horizon. But for the sake of argument, let’s assume that rates do rise from here. What does that mean for the high yield market and the various “strategies” out there to deal with rising rates? Click here to read our recent piece “Strategies for Investing in a Rising Rate Environment.”
The long awaited “taper” has finally come. After months of fear and speculation as to what the end of quantitative easing meant for rates, we saw little response to the actual news in the bond market. But in anticipation, we have already seen a big move up in rates since the lows of the 2013. With unemployment still elevated, very moderate global growth, minimal inflation, and the Fed explicitly clear in the message that tapering does not mean tightening, all the while extending their low interest rate policy for the next couple years, it is unclear that a rapid rise in rates is on the horizon, especially given the big move we have already seen. But for the sake of argument, let’s assume that rates do rise even further. What does that mean for the high yield market and the various “strategies” out there to deal with rising rates? Click here to read our recent piece “Strategies for Investing in a Rising Rate Environment.”
Buying bonds and loans is simply lending a company money. What bank would lend money to every company that walked in the door with a belief that the law of large numbers would play out? Then why do investors believe that owning 600+ names in a passive high yield fund is the way to go?
To us, true high yield investing involves buying money good credits that are undervalued—in other words, paying the right price/generating the right yield given the company’s fundamentals. Instead, in the passive high yield ETFs available today have a huge portion of the portfolio generating a very paltry yield and bonds trading well above their call prices, and then sizable allocations to the highly levered LBOs and distressed investments that generate outsized yields, given the outsized risk. So this is basically the worst of both worlds. On one side, you are generating little yield and seemed to be positioned for principal losses on nearly half of the portfolio because many of the bond prices are currently well above the call or maturity price. On the other side, you are also potentially confronted with losses given the investments in companies facing what we see as likely restructurings in the future.
There is a middle ground for investors that can look for value and are not subject to structural limitations, such as issue size constraints hampering the passive ETFs. It is in this middle ground that we find the real opportunity in high yield investing. Click here to read our recently updated piece “The Necessity of Active Management in High Yield Investing” where we discuss why active management is essential in the high yield market.
We have all witnessed a major move in Treasury rates over the last couple months, causing concern for many that we may well be in the early stages of a rising interest rate environment. The traditional thought is that as interest rates rise, bond prices fall. But looking at history, the high yield market has defied this widely held notion. Let’s examine the four main reasons why high yield bonds have historically performed well during times of rising interest rates. Click here to read more.
I have been an investor in the energy space for over 25 years. Outside of interest rates, I don’t believe there is anything that dominates the global economy more than oil prices. It is a product that touches every area of our lives. Like it or hate it, that is the reality. In my opinion, there is something dramatically wrong, as crude oil and gasoline prices are near all-time highs, yet the global economy remains stuck in neutral. I believe that we are being fed a bunch of nonsense with the rhetoric that the U.S. will be energy independent and that new technologies have released a torrent of new oil reserves. The price action is telling us something else entirely. Click here to read more.
Exchange Traded Funds (“ETFs”) for high yield bonds have become a bigger factor in today’s market. However, we believe that the passive, index-based funds have no ability to deal with risks in the current credit market. This involves credit risk, as well as call and pricing risks. The larger on the run names have become significantly over-valued as current market prices are way above their call price. We believe that this will lead to future principal losses, not from default but from these bonds being called well below current trading prices. Additionally, the passive funds hold numerous credits that in our mind are likely defaults and/or restructurings waiting to happen. By their passive nature, these funds do not sell or steer clear of these questionable securities or the over-valued bonds in today’s market. Furthermore, the largest high yield index based ETFs exclude a huge portion of the actual high yield market due to their issue size minimums.
Active management is essential in the high yield space; what you don’t buy is just as important as what you do buy. As an active manager, Peritus does not have the constraints these passive funds face and that flexibility gives us a dramatic advantage in today’s market.
Concerns about inflation and rising interest rates abound right now. The traditional thought is that as interest rates rise, bond prices fall. But looking at history, the high yield market has defied this widely held notion; instead, high yield has historically performed well during a rising rate environment. We look at the four main reasons that explain the high yield market’s lack of sensitivity to interest rates.
ETFs are one of the fastest growing investment products due to their ease of accessibility and operational tax efficient structure. The benefits to investing in an ETF include access, broad exposure, liquidity, transparency, tax efficiency, and income. Additionally, there are benefits to active management within the ETF space.
As we have discussed over the last few quarters we believe that equity investors have been involved in the biggest head fake in history. The notion that nothing in the economy has been fixed is now coming to the forefront.
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Peritus I Asset Management Disclosure:
Although information and analysis contained herein has been obtained from sources Peritus I Asset Management, LLC believes to be reliable, its accuracy and completeness cannot be guaranteed. These reports are for informational purposes only. Any recommendation made in these report may not be suitable for all investors. As with all investments, investing in high yield corporate bonds and loans and other fixed income, equity, and fund securities involves various risks and uncertainties, as well as the potential for loss. Past performance is not an indication or guarantee of future results. Historical performance statistics and associated disclosures available upon request.