High Yield Fund (HWHIX)

I SHARES    A SHARES    C SHARES   

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 March 31, 2018

 

MARKET COMMENTARY

The ICE BofAML US High Yield Index declined -0.9% in the first quarter of 2018 taking reprieve from its streak of positive performance, which had stood at 8 consecutive calendar quarters.  The Fed raised rates in March in a widely anticipated move, which boosted treasury yields in a fairly uniform manner—short rates increased fractionally more than long rates flattening the yield curve ever so slightly.  At the end of the quarter, the yield-to-worst on the high yield market stood at 6.35%, a 0.51% increase from the beginning of the year.  The high yield market’s spread over treasuries widened by 9 basis points, refusing to absorb the increase in interest rates.  Interestingly, the lowest rated credits (CCC & below) posted a slightly positive return in the quarter while higher rated credits declined the most.  More often than not, lower rated credits underperform when the high yield market falls and outperform when it rises.  Exceptions tend to occur when the market’s decline is due to the increase in interest rates, which transpired this quarter, because higher rated credits are more rate sensitive than lower rated credits. 

All 18 high yield sectors declined in the quarter but the worst-performer declined a rather modest -2.6% (banking).  In the last two calendar years, the best-performing sector outperformed the worst-performing sector by 11 and 34 percentage points, respectively, so this quarter’s sector dispersion was quite narrow.  Small and mid cap credits outperformed large cap credits, which tends to be (and was) conducive to our bottom-up credit picking approach. 

The trailing 12 month high yield default rate including distressed exchanges finished the quarter at 2.36% (par-weighted), which is 0.90% higher than it was 3 months ago.  There were a handful of retail and energy defaults during the first quarter, though the largest individual default was in broadcasting (iHeartCommunications: 0.0%*).  The default rate is lower than it was a year ago, however, largely due to the decreasing number of defaults in the energy sector.  Credits that trade at or below 50 cents on the dollar represent just 0.5% of high yield credits, suggesting the market is not expecting a notable increase in defaults going forward. 

While the market is tighter than average, fundamentals are reasonable and we have invested in credits that our research indicates have strong/quality asset coverage.  We continue to adhere to our core competency of focusing on credits of all sizes as well as fallen angels, which are often overlooked by other investors. 

ATTRIBUTION: 1Q 2018

The Hotchkis & Wiley High Yield Fund (Class I) outperformed both the ICE BofAML BB-B US High Yield Constrained Index and the broader ICE BofAML US High Yield Index in the first quarter of 2018.  Positive credit selection drove all of the outperformance in the quarter; it was most positive in the basic industry, consumer goods, and healthcare sectors.  Credit selection in technology and services were very small detractors to performance.  Market wide, the disparity in performance from one sector to another was unusually narrow.  Consequently, over/underweighting sectors had little effect on performance relative to the benchmark.  

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

Fundamentals (3):  We reduced the Fundamentals score from 4 to 3.  Financial leverage remains in check.  The default rate including distressed exchanges, is 2.36% which is an increase from three months ago but below historical averages.  Less than 1% of the market is trading at distressed levels.  Market maturities are well-termed out, with little near-term refinancing pressures.  The potential for trade wars create some uncertainty.

Technicals (3):  The technicals score remains at 3.  The primary market has $73 billion in new issuance year to date—more than 60% of this was used for refinancing with only 14% earmarked for acquisition/leveraged buyout financing.  CCC-rated new issuance comprised 12% of the primary market, below the historical median of 16%.  Asset class outflows persist. 

Valuation (2):  The valuation score remains at 2 though it has improved.  The market’s yield-to-worst is 6.35% and spreads over treasuries stand at 372 basis points—a tighter than average market.  Excess spreads, or spreads adjusted for unrecovered defaults, are reasonably close to long term averages.

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 3/31/18 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 ICE BofAML US High Yield Index were -0.91%, 3.69%, 5.18%, 5.01%, and 11.84% for 1Q18, one-year, three-year, five-year and Since 3/31/09 periods ended March 31, 2018.

Index definitions

Glossary of financial terms