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 June 30, 2017

 

MARKET COMMENTARY

The BofA Merrill Lynch US High Yield Index returned +2.1% in the second quarter of 2017 and is now up +4.9% since the beginning of the year.  Higher quality credits performed best, which is moderately atypical in a market rally.  Spreads for the overall market tightened by 15 basis points but spreads on credits rated CCC or below actually widened by 21 basis points.  Every sector but one increased during the quarter, with financial market sectors leading the way.  Energy was the laggard, declining -1.3% during the quarter as oil prices declined 9% and 3 high yield energy issuers defaulted.  A little more than a year ago, spreads for commodity sectors were about 1,000 basis points wider than the market average before almost fully converging with the rest of the market.  After the notable widening during the second quarter, energy spreads are now about 150 basis points wider than the aggregate market. 

The Treasury yield curve flattened during the quarter.  Yields on the 2-year increased, yields on the 5-year were flat, and yields on the 10- and 30-year decreased.  The flattening was of modest magnitude, and the yield curve remains normal/upward sloping.  This is something we monitor closely; however, as an inverted yield curve has preceded all seven recessions of the past 50 years. 

Revenue and EBITDA growth have recovered, and financial leverage remains in check.  Distressed debt accounts for less than 1% of the total high yield market; the default rate is 2%, about half the market’s historical average.  Excluding commodity defaults over the past year, the default rate is under 1%.  The market’s “excess spread”, or spread after adjusting for the default rate environment, is 257 basis points—just 36 basis points below the historical average.  The maturity calendar is termed out well, with little near term refinancing pressures.  The primary/new issue market has been well-behaved.  Most new issuance has been higher quality bonds and the proceeds have been predominantly used for refinancing—LBO activity remains muted. 

We continued to identify interesting opportunities in our areas of expertise—small/mid cap credits and fallen angels.  When markets are tight and the preponderance of investors are focused in relatively narrow group of large cap credits, our core competency is a distinguished advantage.  We are able to identify pockets of opportunities in overlooked segments of the market that are difficult for many large institutional managers to access.  ETFs have essentially no exposure to these market segments.  This has facilitated a 64 basis point spread advantage for the portfolio relative to the broad index, and in our opinion, without assuming undue risk. We will continue to adhere to this core competency and are optimistic about the risk/return prospects of the portfolio as we look forward. 

ATTRIBUTION: 2Q 2017

The Hotchkis & Wiley High Yield Fund underperformed the BofA Merrill Lynch US High Yield Index and the BofA Merrill Lynch US High Yield BB-B Constrained Index.  Overall credit selection was decidedly positive but the overweight position in energy credits detracted from relative performance.  The portfolio averaged about 650 basis points overweight energy relative to the broad index—the only negative sector in the market.  Fortunately, positive credit selection in energy offset the majority of the overweight position.  Our positions are focused in credits that have sufficient asset coverage even when using pessimistic assumptions regarding commodity prices. 

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

Fundamentals (4): The fundamentals score remains unchanged at 4.  Revenue growth turned positive and margins have improved, which significantly reduces default risk.  The default rate, including distressed exchanges, fell to 2.0%.  Excluding commodity sectors the default rate is a benign 0.9%.  Leverage has declined and interest coverage has improved.  The maturity calendar is well termed; there is no near-term maturity wall that would pressure refinancing. 

Valuation (2): We maintained the valuation score at 2.  The yield-to-worst of the BofAML US High Yield Index declined to 5.7% and spreads narrowed to 376 basis points—a tight market.  Valuations look more reasonable after adjusting for the low default rate environment.  Excess spreads are only moderately below historical levels.  The narrowing has been led by commodity sectors, which are only slightly wider than the market average.  Other fixed income categories exhibit valuations considerably worse, both in absolute and relative terms. 

Technicals (3): The technicals score remains unchanged at 3.  The new issue calendar is robust and appears to be loosening slightly.  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 continued 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 6/30/17 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 2.14%, 12.75%, 4.48%, 6.91%, and 12.78% for 2Q17, one-year, three-year, five-year and Since 3/31/09 periods ended June 30, 2017.

Index definitions

Glossary of financial terms