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, 2017

 

MARKET COMMENTARY

The BofA Merrill Lynch US High Yield Index returned +2.71% in the first quarter of 2017.  The yield-to-worst fell and spreads tightened, each by about 30 basis points in the quarter; similar duration Treasury yields were essentially unchanged.  Lower rated bonds performed best, which is typical in strong positive markets.  The CCC-rated portion of the index returned +5.2% and CCC spreads tightened by more than 100 basis points.  The top performing sectors, in order, were transportation, healthcare, telecommunications, and utilities.  Retail was the lone negative sector, though it declined by less than one percentage point. 

The market ended the quarter with a yield-to-worst of 5.9% and spread over treasuries of 391 basis points.  With spreads both tight and narrowly distributed, it is not the most compelling environment we have ever observed based on valuations alone.  Nonetheless, we believe high yield valuations appear more attractive than fixed income alternatives, even after adjusting for differences in risk.  Strong market fundamentals are the primary cause of the tight high yield market.  The trailing 12 month default rate has fallen well below average (~2.5%), and is poised to decline further as early-to-mid 2016 defaults roll off.  Defaults outside the commodity sectors have been nearly non-existent, persisting at less 1% over the past year.  Default increases are most often preceded by revenue and margin declines coupled with increases in financial leverage.  Revenues and margins have recently improved; however, and leverage has come down. 

We have been able to identify attractive individual opportunities, though it is more difficult than in years past. We believe our penchant for small and mid cap issuers provides a competitive advantage by expanding our investable universe and allowing us to look at an important segment of the high yield market where opportunities abound.  In the current environment, we have identified attractive risk-adjusted opportunities in basic industry, energy, and consumer goods credits. Our exposures are predicated on our bottom-up analysis of the individual credits.  We believe this approach is a considerable advantage in all markets, but disproportionately so in environments where obvious opportunities are hard to find.  The portfolio maintains a notable spread advantage relative to the market without assuming undue risk.  Going forward, we will maintain our commitment to this time-tested approach and are optimistic about the long-term risk/return prospects of the portfolio.  

ATTRIBUTION: 1Q 2017

The Hotchkis & Wiley High Yield Fund (Class I) outperformed the BofAML BB-B US High Yield Constrained Index and BofAML US High Yield Index in the quarter. There were no notable themes in terms of quality, size, etc.  Our bottom-up credit research worked as designed.  Positive credit selection drove all of the outperformance.  While consumer goods, media, and energy were particularly strong, the positive credit selection was broadly distributed.  In fact, credit selection was positive or neutral in 16 of the 18 Merrill Lynch sectors.  The two negative sectors had a combined effect of -7 basis points.  The largest performance detractor was the underweight exposure to telecommunications, which was among the best performing sectors in the quarter. 

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

Fundamentals (4):  We increased the fundamentals score from 3 to 4.  Revenue growth turned positive and margins have improved, which significantly reduces default risk.  The default rate, including distressed exchanges, fell to 2.5%.  Excluding commodity sectors the default rate is a benign 0.6%.  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.  The dollar has been strong which poses a challenge to businesses that generate revenue outside US borders. 

Valuation (2):  We maintained the valuation score at 2.  The yield-to-worst declined to 5.9% and spreads narrowed to 391 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):  We decreased the technicals score from 4 to 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 outpace downgrades for the first time in nearly 2 years. 

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 3/31/17 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 2.71%, 16.88%, 4.62%, 6.85%, and 12.91% for 1Q17, one-year, three-year, five-year and Since 3/31/09 periods ended March 31, 2017.

Index definitions

Glossary of financial terms