The reason meteorologists aren’t held accountable for their rain or snow predictions is that weather forecasts are made in terms of probability statements rather than absolute outcomes. This is why we forget the thunderstorms that failed to materialize and forgive the snowstorms that nobody predicted – a 60% chance of rain turns into a sunny day; a 30% chance of flurries culminates as a blizzard. While a probability statement provides an out, it also is a barometer of confidence. And, in the case of financial forecasts, the market itself provides such a measure.
While 2013 has been a fantastic year for equity markets and risk assets in general, a dark cloud looms on the horizon. At some point, the Federal Reserve (Fed) will initiate its plan to taper; the beginning of the end of the latest round of quantitative easing will commence and the support for U.S. Treasurys and mortgage-backed bonds will fade. Rates must rise, “they” say. But does the “market” have a view? Read more
The use of the term duration has successfully been adopted by the high yield investment universe over the past few of years. Why? Because all else being equal, lower duration means lower interest-rate risk. And the number-one concern for fixed income investors over the past several years has been a fear of when interest rates will begin their rise to normal levels. In fixed income, if rates rise, the value of your bonds declines. And the longer your duration, the more pronounced your decline, again with the caveat all else being equal. The common way to explain duration is that it measures the sensitivity of the price of a bond to a change in interest rates and is expressed as a number of years. This is an extremely useful way to compare two fixed income investments where all else is equal. We have noticed that in a reach for yield, investors have invested in short duration high yield as a way to both gain the higher yield available in the high yield market while seemingly reducing risk by having a shorter duration portfolio. Read more
Credit research is tough enough without trying to do it with one arm tied behind your back. Back in the day, credit analysts would diligently put together massive spreadsheets with all kinds of metrics that explained all aspects of a company’s financial performance and credit strength. These days, however, you have quant geeks trying to boil everything down to one number that “explains it all” so that picking relative value is somehow “easier.” The most common relative-value graph produced by the Street these days is a plot of leverage versus yields. Well, in our view, easy isn’t the best in the world of high yield credit. We’ve seen numerous “credit pickers” out there focused entirely on leverage, who have totally forgotten the rest of the important credit metrics, particularly, coverage. Read more
Yesterday, my colleague, Phelps Hoyt, gave some insight into how industry conferences play into the work of credit analysts at Principal Global Fixed Income. I want to expand a little on their role in our research process and the objectives I pursue when I’m able to attend an investor conference.
While many conferences are held at interesting or beautiful locations, last week, the desert oasis surrounding my hotel provided little more than a change of setting for my morning run. The busy schedule of each day had me going from breakfast at 7:30 a.m. until wrap-up of the evening reception at 10:00 p.m. I came to the conference with several objectives. First, meet with management teams in order to assess the outlook of their business. Second, build deeper relationships with contacts and management of these companies. Lastly, regain perspective that an ever-volatile market can suppress over time. Here’s how things went… Read more
Last week, I was fortunate enough to attend one of the most-respected high yield and leveraged finance conferences in the world; an event that remains the world’s largest and longest-running leveraged finance conference. Every year, the conference aims is to gather the most important issuers, investors and sponsors to discuss the themes that will shape the business in the year ahead. And while the planners designed an agenda with plenty of informative keynote sessions, I found that the most instructive and valuable sessions were the interactive panel discussions and one-on-one meetings.
As an example, on the evening before the conference officially kicked off, a group of investors had the opportunity to sit down with the finance executives of one of the largest high yield telecom issuers and learn first-hand of their business plans and how those will influence the company’s leverage and free cash flows. It was a great opportunity to get a direct view of all the information analysts and investors have had access to through conference calls and SEC reports, but in a clear and simple manner. Read more
With the recent news surrounding the Detroit bankruptcy lingering in investors’ minds, the Commonwealth of Puerto Rico has recently been the focus of industry press. The pieces tend to focus on many of the credit negatives of the commonwealth that have been known in the credit community for a long time; specifically, its stalled economy, structural budgetary deficit, high debt and pension liabilities, below-average socio-demographics, and declining population. These realities are represented in the commonwealth’s current general obligation (GO) ratings of Baa3 (Moody’s – 10th highest of 21 ratings), BBB- (S&P – 10th highest of 22 ratings), and BBB- (Fitch – 10th highest of 20 ratings). In addition, all three major rating agencies hold negative credit outlooks for the future of the island’s creditworthiness.
While some of the articles I’ve seen do a great job focusing on the systemic risks posed by the wide ownership of Puerto Rico in mutual funds, the ultimate risk of investors in these mutual funds is the potential for a significant decline in the value of their investment because of the overweight exposure in the funds to the debt of Puerto Rico. Read more
There’s an important election coming up on 22 September. Germany goes to the polls and everyone’s expecting current Chancellor, Angela Merkel, to be reinstated. If you didn’t catch my previous post, click here to get a quick primer on the election and the parties involved. Regardless of where the votes go later this month, there are several policy steps that Germany will have to address in 2014 regarding its European neighbors: bonds, bailouts, and banking unions. Read more