Relative Value in High Yield Bonds
MassMutual Premier High Yield Fund
Author: Ticker Magazine
Last Update: Feb 07, 10:34 AM ET
|Investing in high yield bonds can be rewarding for disciplined investors who can use the inherent inefficiencies of this market to their advantage. Sean Feeley, portfolio manager of the Mass Mutual Premier High Yield Fund, and a dedicated team of researchers use deep credit analysis to discover relative value with a long-term investing horizon.
“Deep credit analysis is at the root of our philosophy and investment process, and nearly all of our outperformance comes from credit selection.”
Q: Would you give an overview of the fund?
The MassMutual Premier High Yield Fund has an almost 20-year track record. It is part of the MassMutual Retirement Services platform, and as such, many of the platform’s investors include the fund as one of their high yield investment options.
This particular fund invests in U.S. bonds only. However, as a result of the evolution of the high-yield market, the fund also includes a growing number of cross-border issuers. In this respect, we believe our large, global team gives us an advantage, enabling us to conduct rigorous credit analysis on issuers in both the U.S. and Europe.
Over long periods of time, our goal is to outperform the fund’s benchmark, the Barclays U.S. High Yield Index, without taking undue risk.
Q: How would you describe your investment philosophy?
Deep credit analysis is at the root of our philosophy and investment process, and nearly all of our outperformance comes from credit selection. Our approach is bottom-up, value-oriented, high-conviction and long-term; we do not make allocations based on tactical or technical factors. Even when looking at a smaller-cap or lower-rated credit, we try to be agnostic—if we believe relative value opportunities exist, we will not hesitate to participate.
From the investible universe, we come up with a buy list of several hundred bonds and then narrow that down to between 125 and 150 names that we believe are most likely to outperform. Though we are careful not to overly concentrate the portfolio, we are comfortable being materially overweight a particular ratings band or sector.
When taking a fundamental, bottom-up approach to credit investing, it is critical for the credit underwriting process to be robust. With a more concentrated portfolio like ours, the ability to overcome mistakes can be more challenging, so a thorough understanding of the risks is paramount. This is where our experience, skill set and large team give us an advantage.
Q: What is your investment strategy?
Our overall goal is to build and maintain a portfolio that includes a range of credits with stable or improving credit momentum. That sounds fairly simplistic, but we are constantly looking for names that we believe will compensate us for taking on the added risk associated with high yield. We also see opportunities in credits that have the potential for a positive catalyst, such as an asset sale, that could help us achieve price appreciation.
A recent example of our strategy lies in our approach to the healthcare sector, which has underperformed lately based on concerns surrounding the potential repeal or replacement of the Affordable Care Act and the repercussions on hospitals and other companies in the sector. Despite the negative top-down macro view, we have continued to employ our rigorous, bottom-up approach to select what we believe are good, stable credits that provide adequate compensation based on the level of risk.
Q: What is your research process?
At Barings, our team of research analysts is one of the largest in the global high yield market, with 69 dedicated high yield professionals across the U.S. and Europe. This is one of our largest differentiators, as a team of this size and scale allows us to conduct due diligence and rigorous analysis on every credit we consider. Our analysts also have experience covering industries through multiple credit cycles.
Our extensive research process relies on a feet-on-the-street approach to gain an information advantage—we want to know everything there is to know on a name and be able to show conviction through different points of volatility. My co-manager and I do not rely solely on our analysts; rather, we are in the trenches with them, listening to calls and visiting companies in person. Ultimately, we want the conviction to buy things when they trade lower, and conversely, when the market is overly strong, to harvest gains and trade out of names that no longer exhibit relative value.
In order to assess credit quality, we rely primarily on an internal ratings system. However, because external ratings from the agencies do impact how credits trade, part of our process is to communicate with the agencies to better understand how they determine their ratings. We then compare those external ratings to our own internal analysis and make an assessment from there.
Q: How do you construct the portfolio?
Our goal is to build a portfolio that is concentrated in our best ideas yet constrained against the needs of the strategy. To do this, we look for names we believe will provide the best risk-adjusted returns relative to the benchmark.
At the same time, we do not want to be so concentrated that if something unanticipated happens, we fall far behind the index. The portfolio has limits within particular sectors and ratings categories, and a robust risk-management process measures against these constraints daily so we know where we stand. In general, we are not big risk takers—if we feel quite strongly about a name or situation, we may own a 1.5% to 2.5% position.
Actual construction starts from the bottom up. We model our portfolio name by name, and compare the model portfolio to our benchmark in terms of allocation, yield and ratings. This process starts each day with a meeting of our nine-person investment committee. Analysts, who are charged with coming up with new ideas, make recommendations within their sectors for our review and approval.
After we approve a credit for the buy list, the analyst will assign it a 12-month credit outlook and assess its relative value based on their sector view, and include a price target in their underwriting memo. It is then our job as managers to come up with the right portfolio and to harvest the buy list into something more manageable that makes sense in today’s market from a total returns standpoint.
In general, a portfolio will change a lot during the year, turning over roughly 50% on average. And while we rely on a bottom-up approach, we are also mindful of market technicals which can play a critical role; we pay close attention to fund inflow and outflow activity every day to make sure we are not overpaying for credits.
Q: How does covenant analysis come into play?
A large legal team at Barings helps us review all covenants in a particular indenture. We also have a special situations credit team for more distressed situations to increase our understanding of the covenants and possible scenarios around restructuring.
Within high yield, covenant analysis tends to be somewhat standardized, although there are subtle differences. Well-known issuers in the market can typically garner a more favorable covenant package than others. If a covenant package is a bit looser than is standard, we have to gain comfort with that and make sure we are being adequately compensated in yield for that added risk.
The covenant quality in the market comes and goes. Of late, it has become more aggressive, but not so much so that it is becoming an issue in today’s market.