High Yield Daily Update

I don’t remember the stock market doing this after we (SF 49ers) upset the Cincinnati Bengals in Super Bowl XXIII.  All is well because I bought a house here in Santa Barbara with my Super Bowl check, did pretty well with that investment.

Volatility is back, just ask Velocity Shares with their Inverse VIX product.  What do you do when there is volatility like we have seen?  The volatility in the high yield bond market has been much less than the volatility we have seen in equity markets, but the market prices of many high yield ETF’s have traded well below NAV’s during the past few days.  For investors concerned about the recent market weakness, what should you do?  We believe you should look to what the issues are that are causing the market decline.

In 2008 when the high yield market started to fall, and virtually every bond was falling at that time, there was a reason.  There was uncertainty as to which companies, especially the banks, were going to be standing when the dust cleared.  The economy was weakening, and with that demand.  As an active manager we looked the individual credits that we held, discounted their financials to stressed levels and figured out if the security prices at the time reflected reality of failure.

Here we are again faced with some volatility (though certainly to a MUCH lower extent), but when you look at the catalyst you look to the cause.  It appears the main driver is a better economy (leading to higher wages and maybe inflation) THUS POSSIBLY HIGHER INTEREST RATES.  If rates are going to creep higher where do you want to be?  What kind of asset allocation do you want?

High yield bonds have historically performed well during rising rate environments because of several factors, including higher coupons and lower durations, which can serve to provide some protection against rising rates (see our piece, “High Yield in a Rising Rate Environment”).  Additionally, with our own active strategy, we have the ability to turnover holdings and take advantage of potential opportunities such as reinvesting in some newer issues that have come to market with higher coupons that have been adjusted upward to keep in tune with rising rates.

In this environment we see the economy is improving, companies are doing well, and defaults are near historic lows, so we do not see a lot of risk to the downside.  You add in still low government bond yields around the world, and we believe the demand for high yield debt is here to stay.  When we get volatility, don’t panic; rather that can be an opportunity to dollar cost average.  We believe investors should look to an active manager, like Peritus, who has the flexibility to add to positions and turnover investment holdings to more effectively position themselves for the specific investment opportunities they see in the current market environment, rather than the large mutual funds and ETF’s out there holding hundreds or even over a thousand individual credits.

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