Finding Value In Active High Yield

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June 1, 2018 6:29am NYSE:IEF

From Peritus Asset Management: We have spent our financial careers in the high yield bond market, actively managing various portfoliosand vehicles over our history.


The consistent theme of our active strategy is to focus on where we see value,via high tangible interest income and/or potential capital gains opportunities. This involves looking forsecurities in which we see attractive yield relative to the risk and not subjecting ourselves to arbitraryrestrictions such as ratings or tranche sizes, the latter of which is a primary restriction in the underlyingindexes of the largest index-tracking high yield ETFs. If investors or fund managers put on blinders andsubject themselves to arbitrary restrictions such as tranche size, there is a huge portion of the market thatthey are overlooking, and historically it has often been in these overlooked securities that we find value.

We also look for value in securities that we see as misunderstood by investors. This involves payingattention to industry trends and credit specific issues, as well as undertaking detailed financing and creditanalysis to determine if a specific challenge a company faces is being overblown or temporary, or a potentialupside is ignored and overlooked.

Additionally, our strategy includes a deliberate new issue allocation, whereby we include new and newlyissued high yield bonds. Our goal with this allocation is to improve the strategy’s stability and liquidity asthe data we have seen and our experience indicates that securities are often more liquid immediately afterissuance. Furthermore, in today’s rising rate environment, we see the higher Treasury rates translating tohigher coupon levels on some new issues, which can help further an active manager’s yield/incomegeneration.

Focusing on value also involves looking at where in the capital structure we see the best place to bepositioned. For the most part we find that value in bonds, but in some cases, we view the bank loans as thebetter placed to be positioned. The flexibility within our active strategy to access the loan market expandsour opportunity set and allows us to take advantage of the additional yield opportunities. These loans arebased on a spread over LIBOR and we have seen a significant increase in LIBOR rates over the past year,meaning the total coupon rates on these securities are increasing, adding to income generation. Howeverthe caveat here is that given the increased demand for floating rate loans by those investors concerned abouthigher rates, we have seen a massive wave of repricings on loans pushed through over the last year plus,leading to lower spreads over the base rate in many cases. This can mean that the total interest rate couldactually be falling or going up much less than the LIBOR move would indicate (for further detail see ourwriting “Floating Rate Bank Loans: Rising Rates, Re-pricings, and the Real Income”). We believe thisdynamic also puts active managers at an advantage as they can focus on loans where coupons are notdecreasing and where what we would see as attractive income can still be had.

But that is not to say that floating rate loans are the only place to be positioned in a rising rate environment,rather we see them as a complement to a high yield bond strategy. Because of the larger coupons and lowerduration in the high yield bond market versus certain other areas of the fixed income market, such asinvestment grade corporates, we have historically seen much less interest rate sensitivity (see our piece,”Strategies for Investing in a Rising Rate Environment”). The chart below also demonstrates that the highyield bond market has consistently had a notable yield and coupon advantage relative to the 5- and 10-yearTreasury yields.1

Screen Shot 2018-06-01 at 6.22.53 AM

Even with rates increasing, we expect that notable yield advantage to persist. But again, we believe thatactive management is important in this environment because within in the high yield indexes and theproducts that track them, there are a number of securities with yields sub-5% and spreads over comparablematurity Treasuries of 250bps or less. For instance, 32.5% of the US high yield market trades at a spreadof 250bps or less.2 We would expect there to be much more interest rate sensitivity, and thus the potentialfor price declines, in these securities trading at low yield and spread levels. However, this is only a portionof the high yield bond market and we still see plenty of attractive, higher yielding, less interest rate sensitivesecurities in the high yield market that active managers can focus on.Whether rates continue to increase or not, we believe the active strategy within high yield debt market canmake sense for investors, especially those that are looking for attractive income generation.

1 5-year Treasury yield, 10-year Treasury Yield, data sourced from Bloomberg. The Bloomberg Barclays U.S. Corporate High Yield Indexcovers the universe of fixed rate, non-investment grade debt, sourced from Barclays Capital. Yield, yield to worst and coupon data is based onthe month ending levels from 5/29/1998-4/30/18, with the final period as of the date of 5/24/18.

2 Jantzen, Nelson, CFA and Peter Acciavatti, “JPM High-Yield and Leverage Loan Morning Intelligence,” J.P. Morgan North American CreditResearch, 4/27/18, https://markets.jpmorgan.com.

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. This report is for informational purposes only. Any recommendation made in this reportmay 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. High yield bonds are lower rated bonds and involvea greater degree of risk versus investment grade bonds in return for the higher yield potential. As such, securities rated below investment gradegenerally entail greater credit, market, issuer, and liquidity risk than investment grade securities. Interest rate risk may also occur when interestrates rise. Past performance is not an indication or guarantee of future results. The index returns and other statistics are provided for purposesof comparison and information, however an investment cannot be made in an index.

This article was written by Heather Rupp, CFA, Director of Communication and Research Analyst forPeritus I Asset Management, the sub-advisor to the AdvisorShares Peritus High Yield ETF (HYLD),www.advisorshares.com/fund/hyld, fund distributed by Foreside Fund Services, LLC. For questions,please contact Ron Heller, CEO of Peritus I Asset Management, LLC at rheller@peritusasset.com, 805-879-5620.


This article is brought to you courtesy of Peritus Asset Management.


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