Dave Breazzano, head of Polen’s High Yield Team, joined the Money Life podcast to discuss the state of the high yield market with host Chuck Jaffe. Here are the highlights of their conversation.
Q: Where do you see opportunities in high yield right now?
At Polen Capital, we’re bottom-up managers who focus on individual companies instead of making top-down macro calls. Within the High Yield Team, we focus on middle-market, smaller deal sizes. There tends to be more inefficiency in that space, so bargains can become available. We perceive less opportunity with the larger, more liquid names that everyone else picks over.
Q: Why should an investor feel comfortable investing in CCCs? When you talk about seeing a bargain or an opportunity, what do you mean?
First, we believe an investor must go with an experienced manager. All CCCs are not created equal. Our highly selective investment process leads us to discard about 85-90% of the available CCC-rated securities. We find that there are certain nuances and biases in this category, which can create opportunity but also risk.
About two-thirds of our portfolio is composed of companies sponsored by private equity (PE) firms. PE analysts found these businesses attractive for a variety of reasons. They felt comfortable with the amount of debt within the capital structure and the companies’ ability to service that debt. There’s a big difference between a growth-oriented company – one that has low capital expenditure requirements, generates free cash flow, and has the potential to grow into its leveraged capital structure – and a company that is in secular decline or cyclically challenged with too much debt.
Q: Are you worried we may see more default risk as interest rates rise?
We model our investments over different rate and economic scenarios, and if we’re uncomfortable, we adjust course. If we see enough cushion for a company to survive challenging conditions, it often makes sense for us to stay invested.
What’s important to remember about this market cycle is that when COVID-19 hit, the U.S. Federal Reserve stepped in to inject massive liquidity beginning in March 2020. Many struggling, weaker companies did not make it through this challenging period – they were flushed out of the market. Those that survived were able to take advantage of this highly liquid environment to re-finance their debt, extend their maturities, and in many cases, lighten up their covenants. This means they could position themselves more advantageously for the long term, unlike what happened in 2008-09 with concerns around the “wall of maturity.” We’re simply not seeing the same kinds of triggers today that would suggest a significant wave of defaults in the near term.
All CCCs are not created equal. Our highly selective investment process leads us to discard about 85-90% available.
—Dave Breazzano, Head of Team & Portfolio Manager, U.S. High Yield
Please note that this document is a condensed summary of the full interview conducted by Chuck Jaffe.
This information is provided for illustrative purposes only. Opinions and views expressed in this podcast are as of December 2022 and may involve a number of assumptions and estimates which are not guaranteed and are subject to change without notice or update. Although the information and any opinions or views given have been obtained from or based on sources believed to be reliable, no warranty or representation is made as to their correctness, completeness, or accuracy. Opinions, estimates, forecasts, and statements of financial market trends that are based on current market conditions constitute our judgment and are subject to change without notice, including any forward-looking estimates or statements which are based on certain expectations and assumptions. The views and strategies described may not be suitable for all clients. This document does not identify all the risks (direct or indirect) or other considerations which might be material to you when entering any financial transaction.