Starting in late July and continuing through the first half of August is earnings season for most of our credits, which is a very important and busy time for us. As active managers, we not only evaluate a credit as we make an initial purchase—our alpha-focused bond and loan credit strategy involves a thorough fundamental review—but we also continuously monitor credits once they are held. Earnings season is an important time because it gives us a look at whether or not the credit has met our initial expectations and investment thesis. While top line performance (sales) is of note, we generally pay particular attention to the company’s EBITDA, FCF generation/use, leverage, and liquidity position, as well as the outlook going forward.
As we process all of this data, we evaluate whether any change in the investment thesis is warranted. While in most cases there is no change, our earnings evaluation can result in a sell or an increase in position sizes. For instance, if the company is underperforming and we see further downside exposure relative to the security’s price, we may choose to sell. On the flip side, if we see the security as significantly undervalued, with a disconnect between the credit fundamentals and the credit’s yield/price, we may choose to add to an existing position.
Furthermore, earnings season can create a variety of opportunities for new investments. Often we see a security’s price taken down/yield widen on the company missing expectations or giving an unfavorable outlook, yet we may believe the market is overreacting to the news or the issue causing the weakness is just temporary. This can create an undervalued situation and what we see as an attractive buy-in price—these are the sort of opportunities we look for as a value-focused manager. Or we may have a security that we are watching but as an extra layer of caution want to see how the company is recently performing before we pull the trigger to make an investment, and the earnings announcement allows us to do just that.
This is just part of the merit and worth we see in active management. We are intentional about what we hold and why we hold it. In the high yield market, earnings surprises often have an impact on security prices, so we don’t believe blinding holding something no matter the valuation or outlook is the answer. Per our strategy, we target about 70-100 credits within a portfolio, which we believe does allow us enough diversification to moderate our security specific risk and keeps position sizes relatively low, but also gives us a limited enough number of securities that we are able to evaluate what we hold. In times like this, we believe it is very important to have an active manager monitoring what securities are held and how a portfolio is constructed.