Josh Rank, the lead manager of the Aviva Investors Global High Yield Bond fund, talks to Frances Hughes.
Q: Can you explain why you say now is a good time to enter the high-yield bond market?
A: These spread levels have only featured themselves three times since the advent of high yield, over the past 20-plus years. With spreads in excess of 1000 basis points we are either near, or at, all-time wides in the high-yield asset class. At 13.5% [yield] it is a very attractive entry point. High yield at these levels is protecting against downside risk. At a 13.5% yield and 1000-plus spreads you are compensated for price depreciation and volatility.
If you look back historically over 20 years, the high-yield asset class low is negative [by] 6.02% overall. This compares with lows of more than minus 20% for equities.
We agree defaults are definitely rising. We are at relatively low levels, at 2.6%. Moodys’ estimate 12 months forward is at 7.4%. We don’t know to what point that they are going to rise. But when they rise to 12% and spreads go up to 1200 basis points, your downside is just in excess of 2% in that type of scenario. So really we feel that the downside is protected, because of that significant yield on the asset class.
Q: Some investors might consider unrated or below BBB rated bonds as high risk. How do you respond to that? A:
A:It depends on the issuer. Each individual issuer has different idiosyncratic risks that are attached to it. We are looking at free cash flow, leverage and interest coverage – their ability to service the debt. High yield is what we call a losers’ game. We try to avoid the losers – the companies that default and do not pay back.
Q: Can you describe the investment process on this fund? A:
A:Our primary cornerstone within the high-yield asset class is at the analyst level. We call it the FTV framework. It is not rocket science by any means. F stands for fundamentals, T for technicals and V for valuation. This process is done independently of portfolio management. The F, the T and the V are given an individual rating by the analyst at the security level, which then translates into a buy, neutral or sell. That’s part of the process. This really leads us to proactive investing and keeps our process dynamic.
From a bottom-up perspective, we look for the fundamentals – the drivers of the credit. We focus on leading companies and ask ‘Can this company continue to service its debt?’ And again ‘Are we going to get paid back?’We are also focused on the asset quality. ‘What are the underlying assets of the company? Where are they at in the capital structure?’ That has been important in recent weeks and will continue to be more important as we go through an increasing default cycle.
Q: To what extent do you use quantitative screening? A:
A:We have all of the different screens, but we are not a quant shop. This is fundamental credit research. This is not a levered fund. It does not have structured vehicles. It is purely and simply global high-yield corporate credit.
Q: Is it an advantage to be able to invest globally in corporate credit and if yes, to what extent? A:
A:One of the sources of alpha that we have identified regarding this fund is multi-currency credit. For example, an issuer can have euro and dollar-denominated debt. There is no difference in the credit risk. It is an arbitrage opportunity and having teams on the ground working together gives us a competitive advantage.
Q: Which regions are you most exposed to and what sectors do you like at the moment? A:
A:Primarily the high-yield asset class is for the most part a US dollar asset. The advent of the European high-yield market came with the birth of the euro. So it hasn’t been around that long. So as far as the breakdown of the overall asset class, about 88% of it is in US dollars.
We have a feel from a top-down perspective where these companies’ products are being sold and where they generate their revenues. But again, we are really looking at idiosyncratic risk, bottom-up. The top-down perspective is not our focus.
We are overweight in the healthcare and utilities sectors. We have some large individual issuer exposure there. We have underweights in autos and finance. We also have underweights in a lot of the consumer-related space. In the near-term we will remain defensive.
Q: Are you able to have any exposure to BBB bonds and what proportion of the portfolio is in CCC bonds? A:
A:There is a maximum of 15% in BBB. 85% of the portfolio is invested in bonds that are unrated or less than BBB.
We have less than 10% in CCC in this fund. The overall market is approaching 25%. We have no maximum limit. We look at them on a case-by-case basis. Over the long-term our average weighting in CCCs will be well below that of the market, but we can be opportunistic and tactical when we see value in the CCC sector. There might be points where we want to go overweight CCC. But it will be on a selective basis.
Q: Will you use derivatives? A:
A:Within Ucits III there is the ability to use derivatives. However, this fund is long only. And if we were to use them it would not be for leveraging the portfolio. It would be for efficient portfolio management.
Q: How many holdings are there in the portfolio? A:
A:There are 115 issuers in the fund. The minimum we will hold is 75 and 150 is probably the highest we would go. We want to generate alpha from security selection. If you start getting into a 500-name portfolio, not only can you not follow all those names unless you have 100 analysts, but you are also not benefiting from your security selection because your weighting in each individual name has become so small. You might as well just buy the index.
Q: How do you ensure adequate diversification within the portfolio? A:
A:We have a minimum issuer count of 75 and at least 15 industries have to be in the portfolio. The industries we select will have lower correlations to each other. We want the benefits of diversification.
As far as the correlation to other asset classes and the advantage of having high yield within a diversified portfolio, a lot of people associate high yield with interest rates or treasury gilts, because it is a bond. But the correlation to the US treasury tenure note is 0.16%. So the correlation to treasuries is low. In correlation to equities it is only 0.52%. That’s why high yield is a great diversifier within a balanced portfolio.
Q: The minimum investment in the fund is denominated in euros and dollars. Will you be introducing a sterling share class? A:
A:Yes, in November. We anticipate it will be £2,000.
JOSH RANK is the lead manager on the recently launched Aviva Investors Global High Yield Bond fund, the first product launched under the new brand name.