Broker Check

High Yield Philosophy Overview

We believe that active management based on a long investment horizon will outperform the markets over time. Our investment philosophy is based on the premise that a core portfolio, built around long-term trends and within the appropriate industries over the entire cycle will outperform on average and provide stability and downside protection. Additional alpha is added by investing in out-of-favor industries (including non-traditional high-yield instruments such as REITS, busted convertibles and MLPs), and taking advantage of the pricing premium in “small cap” bond issuers.

Core Portfolio Approach:               

  • Long Term: Our core thinking is long-term focused and centered on secular trends and themes such as demographics, productivity, automation, globalization, etc. These trends and themes are always at the forefront in structuring the portfolio. But by being in the better areas for high yield and away from the poor areas we have the wind at our back and should outperform over the complete cycle. 
  • Understand the industry first: Understanding industry dynamics is critical. Most mangers even if they dislike an industry will be only slightly underweighted. If we don’t think an industry is suitable for high yield we will have a zero weighting.  As such, we rarely invest in deep cyclical companies.  High debt, high capital intensity and at times volatile revenues is, in our mind, not suitable for high yield and we would not want to make that a portion of our core portfolio.  For example, Retail is a sector that we stay away from. On the other hand, our portfolio has consistently been over weighted healthcare, consumer non-cyclicals and services. We also are over weighted defense and gaming as core sectors. We believe if we get the industry correct we are winning half the battle in getting our investments correct.
  • Bottom up Analysis: Once we are comfortable with and industry or sector we will analyze potential investments from the bottom up as if we were the sole owners of that business. We ask: is it structured the way I would structure it, what is the competitive advantage, how does it perform in a down economy, what are the reinvestment needs of the business to keep it competitive, and last what is the return on capital the entire business generates. We don’t start by looking at leverage, rating or bond yield.  We start by buying good businesses.  If you buy good businesses, good things happen.

Out of favor industries and sectors:

Our core thinking leads us to better businesses and industries, and to add value we also concentrate on looking for out of favor sectors and industries.  A defined process is used to evaluate out-of-favor industries. The better companies in these out-of-favor industries can offer good value with limited downside risk. We do not look for individual fallen angels but look for industries or sectors that are out of favor where we can see a catalyst for change.  Typically, that catalyst is as simple as Economics 101, or supply coming out of the industry.  Once we have identified an industry that interests us, that industry/sector will be assigned to a member of the team to analyze the industry in depth and the potential issuers in that industry. We typically will invest in the better companies in the out of favor industry, i.e.  companies that can withstand a 2-3-year industry correction.  During that time, we earn significant income with these companies and they tend to come out better competitors in a more rational industry once the industry corrects.

We have numerous examples of taking advantage of out of favor sectors: from technology companies after the Nasdaq crash, telecom sector after Worldcom took down the industry, the auto sector after GM and Ford problems, airlines as they dealt with overcapacity, financials during 2008, Western Europe companies during the Euro crisis, and most recently the energy sector.  We had zero energy going into the collapse in oil prices because we did not like the industry structure and return on capital the companies were generating – essentially energy did not fit our core thinking as outlined above.  As the sector became out of favor, we gradually increased our exposure to 15%+ of the portfolio in E&P companies versus 6% for the index. Following the recent rally in oil prices we have reduced our exposure to 3% in E&P.

 The market is always volatile enough and provides opportunities in out of favor areas.  Historically we have had about one third of the portfolio in out of favor areas.

Taking advantage of small cap: We will typically have about one third of the portfolio in “small cap’ companies, spread within the core and out-of-favor areas.

We define small cap as companies with $500mm or less in bonds outstanding.  We believe over a complete cycle 100bps extra can be earned in small cap companies vs their comparable quality larger cap peers. Small caps are attractive because the rating agencies penalize small companies just for being small (at a minimum 20% of the rating is the size of the company), despite the quality of the business itself. Further, larger investors ignore these companies because they cannot take a big enough position in the name to make a difference to their portfolio.

To summarize, our core thinking and how we view the high yield market and companies leads us to a more stable core portfolio with what we consider to be better industries and better businesses.  We augment the core by looking for out of favor situations to occur.  Last, we typically invest one third of the portfolio in small cap issuers where we believe we can earn an extra 100bps over time without increasing risk.