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Extreme rigour

09 December 2016

David Rosenberg of Oaktree Capital describes his investment vetting process – and why now is a good moment to hold high yield bonds.

In October, US inflation reached 1.6%1, not far off the Federal Reserve’s 2% target. Futures markets are forecasting that the Fed will raise rates next week – it would be only the second time it had done so since the global financial crisis. Meanwhile Mark Carney, governor of the Bank of England, has forecast that inflation in the UK is set to rise significantly – and said that the Bank may let it rise above its 2% target ceiling.

Bond investors therefore face a new environment, one in which inflationary pressures threaten to offset the value of their income. David Rosenberg of Oaktree Capital in Los Angeles, appointed earlier this year to manage the US high-yield segment of the International Corporate Bond fund, believes that high-yield bonds are especially important in this new environment – although avoids trying to time the market.

“We are not a macro forecaster who says what interest rates or the oil price are going to do – we actually firmly believe that we know we don’t know,” says Rosenberg. “But a lot of the talk at the moment is about interest rates. High-yield bonds are far less sensitive to interest rate rises than investment grade bonds. As a result, they should fare much better than corporate investment grade bonds and Treasuries in rising interest rate environments. High yield is the least rate-sensitive of the fixed-income categories. Right now it is not a bad place to be.”

In this, as in all his team’s thinking about bonds, Rosenberg emphasises risk-aversion above all else. While some bond managers seek to outperform their peers in a given year, Oaktree aims to be in the top quartile – and does so by focusing on the possible downsides.

“To be the very best you have to be so different from the rest of the market in any given year that you risk being the worst, and that to us is unacceptable,” says Rosenberg. “We shoot to be in the top quartile because, over the long run, that results in being the best.”

Oaktree’s defensive approach is reflected not just in an attitude but also in a rigorous vetting process. Thirty years ago, the firm’s founders created a credit-scoring matrix with eight key risk factors. Oaktree managers use this matrix to vet any company they are considering lending to – at length.

“Nowhere in the matrix is there a reference to price – it’s quite deliberate,” says Rosenberg. “You underwrite the credit first. Only if the credit is acceptable will we then talk about yield. You’re much better playing defence than you are playing offence because there is more downside [potential] in bonds than there is upside.”

Yet if Rosenberg remains focused on the fact that Oaktree is ultimately underwriting credit, he is also wary of holding a significant portion of the fund in cash.

“We don’t believe you can time the market and so we always go fully invested,” says Rosenberg. “There’s always some cash because there’s coupon coming in, but we wouldn’t let it go meaningfully above 5%.”

Among his holdings are First Data and Reynolds Group Holdings. Reynolds is a more traditional company that is well-known on the market – Rosenberg likes the stable demand created by the disposable nature of its products (such as waste bags and food wrapping), as well as its secure balance sheet and, finally, its yield.

First Data is a payment processor that is benefiting from the large-scale retail shift from cash to card payments.

“When you are buying pretty much anything with a credit card, First Data sits between the terminal at the retail outlet and the credit card company – transmitting the data and processing the transaction,” he says. “So there is tremendous secular growth just as the cashless society is becoming a reality. Plus it’s gone public and so there is now a tremendous cushion for when things go wrong.”

 

Oaktree Capital is a fund manager for St. James’s Place.

The value of an investment with St. James's Place will be directly linked to the performance of the funds you select and the value can therefore go down as well as up. You may get back less than you invested. 

The opinions expressed are those of Oaktree Capital, and are subject to change at any time due to changes in market or economic conditions. This material is not intended to be relied upon as a forecast, research, or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any strategy. The views are not necessarily shared by other investment managers or by St. James’s Place Wealth Management.

1 http://www.usinflationcalculator.com/inflation/historical-inflation-rates/

Some of the products and investment structures documented within this article will not be available to our clients in Asia. For information on the funds that are available please get in touch.

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