Opportunities for High Yield Investors

Jason Stipp: I'm Jason Stipp for Morningstar. We're visiting Hotchkis and
Wiley in California today and I'm here with Ray Kennedy, the
manager of the Hotchkis and Wiley High Yield Fund. He's here to
tell us a little bit about what he's seeing in the high-yield space
today. Thanks for joining me, Ray.

Raymond Kennedy: Thank you.

Jason Stipp: So, the first question for you; high-yield securities have come
roaring back from the market downturn. We've seen a bounce back
in a lot of areas across the market. So, I'm wondering how,
comparing about a year ago or a little over a year ago to today, the
opportunity set that you're seeing, the sense for valuations that
you're seeing in comparing these two vastly different markets.

Raymond Kennedy: Well first of all, let's put it in perspective. In 2007, our market was
clearly overvalued. In 2008 and probably early 2009, we were
probably undervalued by a substantial amount. Today, we're
probably closer to fair value. On a spread basis, we're still wide by
historical standards by a smidge but clearly, we don't have that
much more room to run unless we have a roaring economic
recovery. By most estimates, I think we're going to have a decent
recovery but not something that's going to drive, spreads back
down to those levels that we saw in 2007. That probably made
most of us pretty uncomfortable.

Jason Stipp: So, if we've had that rising tide that has lifted all boats as part of
the recovery now, is it time to turn to issue selection? Are you still
able to find on an issue-by-issue basis some opportunity out there?
It looks like overall valuations have come back.

Raymond Kennedy: Absolutely. The easy money has been made. This is how a picker
like ourselves and others that are very basically very credit
oriented make money because now, you basically have to really
delve in to the opportunities out there rather than just buying a
whole slew of securities that just look cheap that gives you an
alpha just from that standpoint alone.

Jason Stipp: Sure. So, what kinds of situations are creating value? Where are
you seeing values? Is there any pattern to the values that you're
finding out there as you’re looking issue by issue?

Raymond Kennedy: Generally what you'll find is it's almost industry-driven to some
extent. What you'll find is first of all, recovery in certain sectors.
For example, we watched telecom recover first. But then paper
lagged. Now, we're watching paper recover. So now, you can
usually use those sectors as opportunities.

The one play that we've actually made a lot of money on in the last
few months have been the auto sector. We could all see that we
couldn't keep a SAAR level, that's the sales levels driven by the
annualized approach that was well below the historical level of 11
to 12 and was probably should have been closer to 13. It was
actually at eight million units.

At that level, obviously, the cars cannot be sustained from a sales
basis for a prolonged period of time. You have to come back to at
least mean. So sure enough, you could take advantage of that by
looking selectively at some names. But still it comes down to
individual names.

Overall in high-yield, trying to drive a portfolio strictly by industry
will not win in the long run but it does provide opportunity
selection in the near-term and that's where we found the
opportunities.

Jason Stipp: A question for you on investor behavior. I think because of the
low-yield environment for a lot of investing instruments now,
investors are really out there looking for yield. We've seen a lot of
money come in to bonds and bond funds throughout the recovery.
So, it seems like investors -- I don't know if they're looking in the
rear-view mirror or what it is but as a high-yield manager, how do
you think about the investor interest in bonds and investor
expectations for the space? Do you think expectations are sort of
outstripping reality now as far as the outlook for high-yield, for
example?

Raymond Kennedy: I think, first of all, most the money we first saw was people really
attracted to the valuations, which were just at historic levels. Now,
what we're finding is most investors are attracted to the asset class
largely because of the alternatives out there and from the
standpoint that if you put your cash in a checking account or a
money market account, you're going to earn half percent. If you
put in Treasuries, you're taking a substantial amount of risk with
Treasuries falling as the yields back up. So, they look at this asset
class as basically something that lets you thread the needle so to
speak, where you can basically get some upside and some yield,
and protect yourself if things start changing a bit in the market.

I think most investors realize that we cannot have the returns that
we had historically. That would require us to tighten to Treasuries
plus flat level, which would just be remarkable but you can't
happen. But you clearly have seen investors realize that, "Okay,
this is an asset class that's established. It's done well."

I think we've earned the respect of investors now, which is kind of
comforting after all these years that most bonds actually did, at the
end of the day, pretty well. There was still a large chunk that
defaulted but most did pretty well. So, I think investors realize that
return in kind of a low teens area is realistic, even in a high single
digit and they'll take that, which again is coming from the
standpoint that they're not being greedy also.

Jason Stipp: You mentioned default and some companies did default. There was
a lot of concern in the depths of the credit crisis about companies
being able to roll over some of that debt and continue operations.
How is that situation changed on a fundamental level? Do you
think that some of these concerns that we had have really abated or
is it just sort of a short-term fix that we've seen with the flow of
credit and all the intervention that we saw?

Raymond Kennedy: Great question. The way I look at the market is there were really
two types of names in the market, three if you want to throw in
kind of troubled names like a Charter Communications that for a
long period of time just eventually had to restructure because they
were carrying heavy debt loads. But the other two were the mega
LBO’s, which were done in the 2005 to 2007 eras. They probably
will not get out of their capital structure. All they've done is bought
themselves some time and the market reflects that in their pricing.
Most of those bonds are trading in the $60.00 to $70.00 area and
possibly in a bankruptcy that will get lower recoveries.

The core of the market or most of the names out there, this
injection of capital really by investors, who basically started
investing back in the high-yield asset class, has actually helped
recover this market by providing the ability to buy new issues.
Most of those new issues are used to terming out debt. In fact, one
number that I saw out there suggested that if you look at this
maturity wall that we all refer to in 2012, 2013, that we may have
taken out as much as almost $100 billion of that maturity out over
the last 12 months.

Now, the problem with those numbers is that there's been a lot of
activity going on with the case of extensions with bank debt and
everything else. But the fact is we have actually refinanced a ton of
debt. Again, liquidity causes a default at the end when you run out
of cash, obviously. So, to the extent that companies can extend
their maturities and not run out of cash, they in essence, solve their
own problem.

Jason Stipp: Great, thanks so much for joining me today and for your insights
on high-yield.

Raymond Kennedy: Great, thank you.

Jason Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.