High Yield Fund (HWHIX)

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The performance data quoted represents past performance and does not guarantee future results. Current performance may be lower or higher. Investment return and principal value of the fund will fluctuate, and shares may be worth more or less than their original cost when redeemed. Click quarter-end or month-end to obtain the most recent fund performance. The High Yield Fund imposes a 2.00% redemption fee on shares held for 90 days or less. Performance data does not reflect the redemption fee. If it had, return would be reduced.

Manager Commentary
Period ended September 30, 2017

 

MARKET COMMENTARY

The BofA Merrill Lynch US High Yield Index returned +2.0% in the third quarter of 2017 and is now up +7.0% year-to-date.  This marks the 7th consecutive positive quarter for the high yield market.  The good news is that the market is healthy.  Revenue and profits are up, defaults are down, financial leverage is moderate, and the new issue market has been reasonably well-behaved.  The bad news is that much of this good news is reflected in the market’s valuation.  The yield-to-worst fell and spreads tightened by about 20 basis points each and now stand at 5.5% and 355 basis points, respectively.  The tightening was consistent across ratings during the quarter, and small cap credits tightened slightly more than large cap credits.  Treasury yields were largely unchanged. 

The energy sector, which was the largest laggard in the previous quarter, was the top-performing high yield sector by a considerable margin. West Texas Intermediate crude prices rose by 12% over the quarter.  Utilities, services, and basic industry credits also performed well, while telecom and retail lagged—though all sectors were positive. 

Excess spreads, or spreads adjusted for unrecovered defaults, are below long term averages but only slightly so.  This is due to low defaults as opposed to wide spreads, of course.  Across the entire high yield market, there was only one default in July (True Religion Apparel), no defaults in August, and one default in September (Toys R Us).  This was the first time in more than 5 years when one or fewer defaults occurred in three consecutive months.  The high yield market’s default rate declined to 1.3%, well below long-term averages, and less than 1% of the market is priced as distressed.  Energy sector defaults had been elevated until recently, but most of the sector’s cleansing appears to be in the rear view mirror.  Commodity spreads have tightened accordingly, and are now only about 50 basis points wider than the overall market. 

While the high yield market’s valuation is not exciting, pockets of opportunities remain for diligent bottom-up credit pickers.  Our focus on small and mid cap credits along with fallen angels has helped us construct a portfolio with a spread advantage relative to the broad market and BB-B indexes.  This is a core competency that we view as advantageous in all environments, including those when spreads are tight and narrowly distributed; it distinguishes us from the index and our peers. 

ATTRIBUTION: 3Q 2017

The Hotchkis & Wiley High Yield Fund underperformed the BofA Merrill Lynch BB-B US High Yield Constrained Index and the BofA Merrill Lynch US High Yield Index.  The overweight allocation to energy and underweight allocation to telecom was favorable to relative quarter performance.  Energy was the best-performing high yield sector, by far.  Positive credit selection in healthcare, utilities, and media also helped.  On the negative side, credit selection in basic industry, telecom, and services detracted from performance. 

OUTLOOK (Scoring Scale: 1 = Very Negative . . . . 5 = Very Positive)

Fundamentals (4): TThe fundamentals score remains unchanged at 4.  Revenue grew by 6% and EBITDA grew by 8% over the prior year, reflective of Corporate America’s overall health.  The default rate continued to fall, and is now a mere 1.3% including distressed exchanges.  Less than 1% of the market is priced as distressed (<50% of par).  Leverage has declined and remains well within typical levels.  The high yield market is well-termed with little near-term refinancing pressures. 

Valuation (2): We maintained the valuation score at 2.  The yield-to-worst declined and spreads narrowed, both by about 0.2% during the quarter.  At 5.5% and 355 basis points, respectively, the market has been more attractively valued before.  Strong fundamentals support the higher valuations. 

Technicals (3): The technicals score remains unchanged at 3.  The new issue calendar is robust and appears to be loosening slightly.  Flows have been moderate.  Low rated new issuance increased from a 12 year low to average levels.  Liquidity across the market has improved over the past year, as bond dealers have increased inventory levels.  Also, rating agency upgrades continue to outpace downgrades.

Mutual fund investing involves risk. Principal loss is possible.  Investments in debt securities typically decrease in value when interest rates rise. This risk is usually greater for longer-term debt securities. Investment by the Fund in lower-rated and non-rated securities presents a greater risk of loss to principal and interest than higher-rated securities. The Fund may invest in derivative securities, which derive their performance from the performance of an underlying asset, index, interest rate or currency exchange rate. Derivatives can be volatile and involve various types and degrees of risks. Depending on the characteristics of the particular derivative, it could become illiquid. Investment in Asset Backed and Mortgage Backed Securities include additional risks that investors should be aware of such as credit risk, prepayment risk, possible illiquidity and default, as well as increased susceptibility to adverse economic developments. The Fund may invest in foreign as well as emerging markets which involve greater volatility and political, economic and currency risks and differences in accounting methods.

Fund holdings and/or sector allocations are subject to change and are not buy/sell recommendations. Current and future portfolio holdings are subject to risk. Portfolio managers’ opinions and data included in this commentary are as of 9/30/17 and are subject to change without notice.  Any forecasts made cannot be guaranteed.  Information obtained from independent sources is considered reliable, but H&W cannot guarantee its accuracy or completeness. Portfolio’s absolute performance may reflect different results. The Fund may not continue to hold the securities mentioned and the Advisor has no obligation to disclose purchases or sales of these securities. Attribution is an analysis of the portfolio's return relative to a selected benchmark, is calculated using trade information and does not reflect the payment of transaction costs, fees and expenses of the Fund. 

Credit Quality weights by rating were derived from the highest bond rating as determined by S&P, Moody's or Fitch. Bond ratings are grades given to bonds that indicate their credit quality as determined by private independent rating services such as Standard & Poor's, Moody's and Fitch. These firms evaluate a bond issuer's financial strength, or its ability to pay a bond's principal and interest in a timely fashion. Ratings are expressed as letters ranging from 'AAA', which is the highest grade, to 'D', which is the lowest grade. In limited situations when none of the three rating agencies have issued a formal rating, the Advisor will classify the security as nonrated.

Investing in high yield securities is subject to certain risks, including market, credit, liquidity, issuer, interest-rate, inflation, and derivatives risks.  Lower-rated and non-rated securities involve greater risk than higher-rated securities.  High yield bonds and other asset classes have different risk-return profiles, which should be considered when investing.  All investments contain risk and may lose value.

The average annual total returns for the BofA Merrill Lynch U.S. High Yield Index were 2.04%, 9.06%, 5.87%, 6.38%, and 12.65% for 3Q17, one-year, three-year, five-year and Since 3/31/09 periods ended September 30, 2017.

Index definitions

Glossary of financial terms