Manager focus: Phil Milburn

Aegon Asset Management’s Phil Milburn says that forecasts for default rates in high yield debt are too high, and with yields of 25% on offer, the asset class looks attractive.

The investment manager says that Moody’s default rate forecast of 15% in 2009 is the most bearish, and that he thinks the rate is more likely to be between 8% and 10%.

“The economic outlook is dire: we know economic growth is going to be below trend as de-leveraging continues. However I do not think this is the end of the world, and policy action will help,” says Milburn.

He adds that default rates are inversely correlated to real American gross domestic product (GDP), so defaults will be pushed up.

However, Moody’s prediction is too high, he says, first because its methodology makes the figure appear higher, and second, because of liquidity and covenants that are triggered when a company defaults.

Thirdly, he says, figures depend on the definition of a default: “There are lots of debt for debt exchanges being offered by companies. The benefit of this is the uplift in capital price and move higher up in the capital structure. The downside is you will lock in the losses. But I would say if you are not forced to do it, is not a default.”

On the other hand, he points out, is if companies delay defaults, this can cause larger debts and bigger losses for bondholders.

However, with a default rate of 9% and a yield of 25%, a return in the mid-teens should still be attractive in this kind of market, adds Milburn.

As a result of this view, he has been reducing the high cash levels on the High Yield fund to take advantage of buying opportunities.

Last year, cash peaked at 17.5% and is now down to 11%, but this has been pushed up by inflows in recent weeks. Milburn aims to hold around 5%.

He says that in September high yield total returns fell by 10%, and in October by a further 20%. At this time, Milburn began to pick up assets from distressed sellers as spreads rose to 20% over index levels.

“I think this is still ridiculously cheap,” he says.

He is backing companies in defensive areas of the market, and prefers financial leverage to operational leverage where earnings can halve quickly.

He holds bonds in telecoms such as Tele Danmark and Virgin Media and utilities such as Windstream, Intergen, First Hydro, Southern Star and Elwood Energy.

“Everything is cyclical, but these are less cyclical,” he says. “The end consumer, whether it is a business or residential, will always want to consume these products. The top line may go down a bit but they are not going to switch off altogether. They are fairly recession resilient.”

He also likes gaming companies, despite having lost on them in the past.

“We made a few mistakes. The casino firm Harrahs suffered as the downturn in Las Vegas was worse than expected, and the overbuild in the region also had an impact. There are also less people staying in hotels.”

Bonds for lottery companies in Italy and the Czech Republic also feature on the High Yield portfolio: Milburn says that buying a lottery ticket is a small expenditure which becomes a habit people are likely to continue during the downturn.

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