Our investment strategy focuses on generating what we believe to be an attractive yield relative to the risk being assumed.  We view risk as the risk of default and/or loss.  Yield can come from bonds with high coupon rates priced around par, from bonds with lower coupons but trading at sizable price discounts, or a combo of both high coupons and price discounts.  We certainly aren’t distressed investors, but we don’t shy away from price discounts as capital gains can be a huge piece of the picture in generating total long-term return for investors.

Understanding our investment philosophy helps investors understand our portfolio positioning.  We are value-based investors, intentionally looking for value in areas others aren’t.  By the nature of value investing, we are often contrarians, finding value in specific securities or industries that we believe are out of favor for wrong or temporary reasons.  And looking for value can often lead to bonds priced at a discount to par or call prices, in some cases at a substantial discount, as we are currently seeing.

Part of active investing is buying in at the right price.  While some may see discounts as a reason to be concerned—as they seem to assume the market always has it right—we instead see certain discounts as an opportunity.  We certainly don’t believe the market always (or even usually) has it right and just because a bond is trading at a discount to par value, that doesn’t mean a default is likely.  We thoroughly evaluate the fundamentals of the companies in which we invest and if we view the credit as having a viable business and capital structure, we believe that a lower buy-in price actually lowers your risk because you aren’t having to pay as much for the underlying assets and you aren’t buying at the top of the credit cycle.  The more undervalued the security relative to the fundamentals, the lower we see the risk.

As we go through the earnings season we believe we are seeing a disconnect between the security price and the credit fundamentals in many credits.  As we look at our own portfolios, we are seeing some commodity and telecom companies that have huge cash balances relative to their outstanding debt that are trading at big discounts seemingly because they are grouped in out of favor industries.  While we believe much of the energy space should be avoided, we are seeing selective energy companies with much of their production contracted for the year ahead and generating cash, with bonds trading at discounts.  Importantly, the companies also pay attention to the discounts on their bonds and in some cases, the company itself has become the bid.  We are also seeing companies in a variety of industries taking advantage of the price discounts to buy back some of their bonds, whereby lowering their debt levels and interest obligations—certainly not an action we would expect a company to take if a liquidity crunch, bankruptcy or restructuring was on the horizon.

As mentioned above, we are not distressed investors but over our history have not shied away from discounts or taking advantage of price hits due to market liquidity concerns, forced sellers, or people not paying attention to fundamentals.  People often see periods of volatility within the market as a time to sell but we view it as the exact opposite; we see it as an opportunity.  We are seeing companies generating cash flow, with strong liquidity and no bankruptcy concerns from our analysis, but getting hit as sellers come out.  We see this as the time to be taking advantage of the discounts and buying.

Our portfolios are not built for hot money investors, going in and out of the asset class.  We position our portfolios for what we see as attractive return prospects for the long-term, though given our value-based approach, at certain times it can take months and even quarters for that value to be realized.  With the help of the discounts currently offered in the high yield bond and loan markets, we believe that helps position active, value-based managers and investors to generate returns over the long-term with respect to what we see as an attractive, tangible yield and very real capital gains potential.