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Posted by on Oct 12, 2015 in Market Insight, Peritus Asset Management

The High Yield Market: Now’s the Time for Active Management

The High Yield Market: Now’s the Time for Active Management

By: Heather Rupp, CFA, Director of Research for for Peritus Asset Management, Sub-Advisor of the AdvisorShares Peritus High Yield ETF (HYLD)

 
It is during volatile and uncertain times like this in the economic cycle that active management matters the most. When markets are in a one-way trade up, investors can ride the wave and indexing may work. But that doesn’t work for the entire economic cycle. Right now we are seeing a re-pricing of risk as well as weakening fundamentals in certain industries and companies, such as certain commodities, gaming, and energy names as oil prices decline and concerns about China slowing and global growth in general heat up.

Active management is essential for investors to determine where there is value and where there are bombs waiting to happen. For example, we have been vocal about our concerns with certain industries and companies in the energy space, namely the shale exploration and production companies and the companies that service them. Many of these companies weren’t generating cash flow after capital spending with oil at $100, and now that cash generation and profitability is even further constrained with oil at $50. And service companies that cater to the shale producers are facing pricing pressure and declines in drilling activity. Additionally, hedges are starting to roll off, meaning the impact of the current pricing oil environment will more fully be felt, and credit lines will likely be cut over the coming months as banks re-evaluate asset values based on current oil prices. This could lead to further liquidity constraints in the sector. While there are bombs that must be avoided in the energy space, there are selective credits in the sector that we believe offer investors long-term opportunities. Active management is essential for determining the difference. For instance in the energy space, our focus has been on

Canadian producers who benefit from costs in the declining Canadian dollar and sell product in the appreciating US dollar. With the slower growth out of China having an impact on certain areas within the commodity and gaming industries, investors here must also parse out the hugely undervalued securities from the prospective defaults or companies that will face further pressure. What you don’t buy is as important as what you do buy.

In passive investing, fundamentals are not the primary focus in compiling the portfolio. It is only after a default that a security is removed from the index, and generally the passive products that follow it. Instead of staying ahead of the curve and trying to avoid defaults/questionable securities or position yourself in the more senior names in a capital structure, passive funds largely just hold what is part of the underlying index, irrespective of the credit fundamentals or prospects. If you see a train coming towards you, you’d get out of the way, but here, they can’t.

Active managers can deliberately position their portfolio for the current economic environment and outlook. Today, this becomes important as we consider interest rates. While we aren’t believers that we will see a huge increase in rates, duration is still important in times of rising rates and active investors are able to position their portfolio accordingly.

Active management is proactive not reactive. We are seeing some of the best opportunities in the high yield space that we have seen for years—when prices are down, your prospective return can increase—but it is essential to determine the real opportunities from the time bombs waiting to happen and position the portfolio for the environment we are in.
 

Although information and analysis contained herein has been obtained from sources Peritus I Asset Management, LLC believes to be reliable, its accuracy and completeness cannot be guaranteed. Information on this website is for informational purposes only. As with all investments, investing in high yield corporate bonds and loans and other fixed income, equity, and fund securities involves various risk and uncertainties, as well as the potential for loss. Past performance is not an indication or guarantee of future results.

The AlphaBaskets blog provides frequent market insight and commentary by AdvisorShares Investments, LLC, created by AdvisorShares and other leading active managers.  AdvisorShares Investments is an SEC-registered investment adviser and the investment adviser to the AdvisorShares actively managed ETFs. The views expressed on AlphaBaskets should not be taken as investment advice or a recommendation for any of the actively managed ETFs advised by AdvisorShares.

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