The Technical Piece of Active Management
By Heather Rupp, CFA, Director of Communications and Research Analyst for Peritus Asset Management, Sub-Advisor of the AdvisorShares Peritus High Yield ETF (NYSE Arca: HYLD)
Over the years we have spent a great deal of time discussing fundamental analysis and how important we believe it is in high yield investing. Fundamental analysis—digging into a company, understanding what they do, and evaluating the future outlook for the business—is at the core of what we do as active managers. However, market technicals also do have a place for us within our actively managed strategy.
Over the past few years, liquidity within the high yield market became an area of focus among investors and regulators alike. In order to address liquidity within our investment strategy, nearly a year ago we proactively decided to allocate a portion of our portfolio to newly issued bonds. Various market data and our own experience had, and has continued to, show that bonds tend to be most liquidity immediately after issuance (see our pieces “Liquidity Management” and “Strategy Adjustments: New Issue Allocation”). Our goal with this strategy adjustment was to increase the liquidity as a whole and work to reduce volatility.
As we allocate money to these newly issued bonds, we play close attention to market technicals. We work to gain an understanding of the general primary market supply/demand conditions. Are markets executing discipline in allocating money to newly issued bonds? Are investors accepting lots of less favorable uses of proceeds (such as for M&A or dividend deals) causing leverage to increase to elevated levels, and or are underwriters getting more aggressive in their structuring, such as with PIK Toggle deals? Do we see any red flags raised that warrant extra caution? We also look at the supply/demand dynamics for the individual bond tranches we are looking at for investment. For instance, is there a strong demand, meaning there are likely many buyers after the deal prices and breaks for trading?
Within this new issue strategy, we have the ability to set coupon thresholds, not participating in the deals with very low coupons where we don’t believe investors are getting compensated for the risk. We can also focus our attention on structures that we prefer, side-stepping PIK-toggles as that may put the investor at risk of receiving coupons in-kind instead of in cash.
As an active market participant, we are looking at both market and individual credit fundamentals and technicals as we execute on our investment strategy. Not only do you need to understand what is going on at the company levels in terms of their earnings and outlook in the midst of the broader economic outlook, you also need to understand supply/demand conditions within the market, especially for bonds that are about to be issued.