Short BB-Rated High Yield Fixed Income

Chartwell's philosophy of high yield bond management stresses preservation of principal and compounding of the income stream as the keys to adding value in the high yield bond market. Unlike many asset classes, the security market line associated with high yield investing over a full market cycle is negatively sloped, with increased risk associated with decreased return. Accordingly, our focus is on the higher quality tiers of the market, which offer an attractive yield premium but a sharply lower incidence of credit erosion relative to the market as a whole. In evaluating investment candidates our perspective is that of a lender. We prefer low beta companies with proven, predictable business models. We utilize both objective and subjective screens to identify the universe of acceptable investment candidates. In particular, we focus on large capitalization issues demonstrating attributes of financial transparency, stable-to-improving cash flow, internal deleveraging capacity, and ample financial flexibility. Rigid sell disciplines ensure that both winners and losers are identified and monetized on a timely basis. Chartwell believes that the consistent application of high credit standards and strict trading disciplines is the most predictable route to outperformance in the high yield bond market.

The high yield bond market is over $1 trillion in size and consists of over 1000 issuers. The
short duration BB-rated strategy focuses exclusively on BB-rated bonds with 0 – 5 years to maturity. This unique niche is a $150 billion (approx.) subset of the overall high yield market. In addition, we apply a series of financial tests, focusing on EBITDA coverage of interest expense and CAPEX, total leverage, projected liquidity, and asset coverage of total debt. The result is a working universe of approximately 150 issuers and 300 issues.

The working universe is allocated by industry across our 5-person research team, which results in a practical research load of 20-30 issuers per analyst. Fundamental research is then done to evaluate 3 types of risk: Business Risk (market share, cost structure, management , etc.), Financial Risk (cash flow stability, capital intensity, credit ratios, etc.) and Covenant Risk (security, limits on debt, restricted payments, change of control, etc.). Finally, we determine whether the bonds offer value in the context of its industry peers and the overall market.

A formal credit committee meets weekly to address new purchase ideas, assess credit developments, and set portfolio strategy. The investment selection process is primarily bottom-up, with business cycle and interest rate analysis incorporated into the determination of industry exposure. New purchase decisions are debated by the group as a whole, and must be unanimous. Sell decisions may be initiated by any individual member of the credit committee, and are triggered by adverse credit or industry developments, price depreciation relative to the index, or excessive spread compression. Portfolios typically consist of 25-35 issues, with a maximum issuer weighting of 5% and maximum industry concentrations of 15%. The portfolio’s maximum average maturity is 3 years, and no leverage, derivatives, or emerging market bonds are used in the portfolio’s construction.

 Download PDF

Statistics as of 12/31/16