Former PIMCO veteran Ray Kennedy of Hotchkis and Wiley High Yield says that the asset class is fairly valued, but a myriad ...
of individual opportunities can still be found.
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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.