Managing Volatility

As we have talked with advisors and investors over the past couple years, we often hear the topics of yield and volatility mentioned.  Investors are looking for yield and income generation, especially in the persistently low yield environment we’ve seen for years now, but they also don’t want to go out on a limb in terms of volatility, as they want to protect their or their clients’ money.  Caution seems to be the investment mindset of choice these days.

We have heard these calls for lower volatility and over the past year have worked to dampen the volatility within our own strategy.  Below are some of the actions that we have taken along this effort:

  • Increasing the number of positions: While we certainly don’t want to take the “one-of-everything” strategy that seems to be employed by many index-based and other large funds that hold hundreds and even over a thousand securities, we have expanded our number of holdings.  The law of diminishing returns comes into play as you get to a certain number of holdings; thus we don’t see holding hundreds of securities as to your advantage.  Rather we want to hold the right securities; enough diversification to work to lower security specific risk and volatility while still staying true to our active strategy.
  • Monitoring Position Sizes: Holding a broad number of individual securities alone isn’t enough.  We also continually monitor our position sizes.  For instance, with the big run up in certain of our holdings in 2016, we saw some of these securities become overweights within our portfolio.  Thus, as we see fit, we have and will continue to work to trim back position sizes to levels we see as appropriate.
  • New Issue Allocation: As we have spoken about on numerous occasions, we have implemented a strategy enhancement of allocating a certain portion of our portfolio to newly issued bonds.  Our experience has been that these bonds tend to be well vetted prior to issuance, which can help minimize the unfavorable surprises in the weeks and months following issuance—meaning less potential downside volatility.  Additionally, our experience has been, and market research indicates, that bonds tend to be more liquid immediately following issuance, which may also serve to help managed liquidity.
  • New Issue Sell Disciple: Part of the new issue strategy involves continually rolling out of prior new issue holdings into more recently issued bonds.  By and large our experience over the last year has been that we are selling these holdings at premiums to issuance price, allowing for potential capital gains.  However, we have implemented a tight sell discipline on downward price movements, which we believe will allow us to better protect on any potential downside, further enhancing the volatility focus of this portion of the portfolio.

As we look toward 2017, we believe that active management and the ability to manage downside volatility will be all the more important for investors across the broad spectrum of asset classes, including high yield: we expect that in 2017 what you own and, importantly, what you don’t own will matter.  We have decades of experience in actively managing high yield portfolios.  Our end goal has been and will continue to be to generate alpha for our investors.  We believe the skill set we have acquired over these years in managing high yield debt allows us to continue with that goal of alpha generation all the while working to manage downside volatility with recent actions taken.

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 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. High yield bonds are lower rated bonds and involve a greater degree of risk versus investment grade bonds in return for the higher yield potential. As such, securities rated below investment grade generally entail greater credit, market, issuer, and liquidity risk than investment grade securities. Interest rate risk may also occur when interest rates rise. Past performance is not an indication or guarantee of future results. Actual results may vary depending on market conditions, among other factors. The index returns and other statistics are provided for purposes of comparison and information, however an investment cannot be made in an index.
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