Monday, April 3, 2006

A Broad Look at High Yields

News Article
April 3, 2006

Business Week Online

A Broad Look at High Yields

Julius Baer Global High Yield Fund manager Greg Hopper sees rich returns in Europe and in local-currency emerging-market debt

The high-yield market offers more opportunities if you go abroad, according to portfolio manager Greg Hopper. He looks for junk bonds issued in South America and Indonesia, as well as Europe and the U.S. for the Julius Baer Global High Yield Fund (BJBHX ). "This is a global search for yield," Hopper says.

The fund has racked up benchmark-beating numbers in an increasingly challenging segment of the market, particularly with General Motors (GM ) and Ford (F ) credit entering junk-bond status (see BW Online, 1/27/06, "Tough Times in the Junk Yard"). Julius Baer Global High Yield posted three-year annualized returns of 13.9%, compared with 5.94% for its style peers and 4.97% for the Lehman Brothers Global Aggregate Bond Index.

Launched in December, 2002, the fund recently earned five stars in its first Morningstar rating. Its expense ratio, recently capped at 1%, is about average for its category. Hopper manages $240 million in global high-yield assets for Julius Baer, including the $40 million fund.

He recently spoke with BusinessWeek Online reporter Marc Hogan about his outlook and about taking an equity approach to fixed-income. Edited excerpts from their conversation follow.

The Fed finally made its move, raising rates a quarter-point and leaving the door open for more tightening. What's your take?
For high-yield, interest rates don't have as much significance as for higher grade bonds. The announcement looked a little more aggressive than people were expecting. I don't think it changes the prognosis significantly.

People are expecting further Fed hikes depending on what kind of numbers we see in the economy. As the short-term rate goes up, it's hard to see how the longer-term rates don't continue going up as well.

Tell me a little about the philosophy of the fund.
The world doesn't need another high-yield fund. What we decided to do was create a fund that takes a much more comprehensive view of what high-yield is. We're not just looking at what's defined as high-yield by the Wall Street underwriters and put into their indexes, which is mostly plain vanilla.

What we want to do is look beyond that and look at, for example, European high-yield. We look at emerging market bonds, both hard currency- and local currency-denominated. For example, we have in the past owned local currency government bonds of Colombia, denominated in pesos. We will look also at things like busted convertible bonds and preferred stocks, as long as they're senior to equity.

Why did European high-yield bonds fare so well last year?
Partly because they're still rebounding from a horrible beginning to that market a few years ago, right in the midst of the telecom crisis. Telecom represented as much as 20% of the U.S. high-yield market at its peak. It was more like 40 or 50% in Europe.

The other aspect to Europe vis à vis the U.S. last year is that there was a lot less issuance relative to the flow of money into the market, particularly toward the end of last year.

What are you finding there now?
I'm marginally more positive on Europe than I am the U.S., if for no other reason than at its doorstep is Eastern Europe. You've got Poland, and Slovakia, and more recently Ukraine, despite their political trials and tribulations. These are all tremendously promising new economies.

That brings us to emerging markets. What opportunities do you see?
We haven't liked hard currency emerging-market debt for the better part of 18 months. It's very tight. Where we see opportunities is in local currency debt of places like Brazil, Columbia, and Indonesia.

What spurred the double-digit returns last year in Brazil and Turkey?
A lot of these major emerging markets are beginning to reap the benefits of political and economic reform that has been taking shape over a number of years. There is a lot going on beneath the surface in terms of modernizing the tax laws, bankruptcy laws, and financial regulations.

All this has a cumulative effect. That, with a backdrop of global stability -- economic stability, at least -- has been tremendously beneficial for some of these major economies.

Let's talk about a few of your top holdings and why you like them.
I can't talk too much to specific issues, but in general, we are looking for credits in companies that have stable to improving fundamentals. If they're deteriorating, we don't buy them, on the theory that it's already in the price.

We want to see some stability. We look at it from an equity standpoint. We don't care what currency they're denominated in or the fact that they may be in an industry that's in favor or out of favor.

So we end up with companies like TRW, an auto parts supplier (TRW ). We no longer have it, because it was tendered out of the portfolio, but it gives you a sense of how we approach things.

Many years prior to its current ownership, TRW had bought another auto parts company called Lucas Varity, which is primarily Europe-based. The TRW bonds are all in the index, and our favorite competitors are chasing after those bonds day in and day out. They're pretty fully priced. But Lucas Varity bonds were interesting to us for a number of reasons that made them ugly to everybody else.

First of all, they were denominated in pounds sterling. That's a nonstarter for most funds to begin with. We, on the other hand, want to find good credit and a bond at the right price. If we have currency risk at the end, we then decide what we want to do with it. So that was not an impediment.

Second, the bond was a 30-year, and many high-yield players don't like to go much beyond 10 years. I find this a little bit absurd, because these companies usually either go bankrupt or get bought or morph themselves into something else within three or four years. So whether I buy a 10-year or a 100-year, there's not a lot of difference.

The third reason most high-yield managers didn't like the bond is because it was non-callable. Most high-yield bonds are callable. In my mind that was a sign of why I should like it, because I wasn't giving the company all these options to call the bond away from me if the situation improved.

As Lucas Varity and TRW continued to improve, I reaped all that benefit. The company tendered the bonds away from us at a very healthy premium to what we bought them at. That's an example of the kind of thing I believe we can do by taking a much broader look at what's out there.

What factors are influencing your outlook?
My outlook is definitely more positive than most. People love to hate high-yield. Right now people are particularly nervous about it because spreads are relatively tight to recent history.

I don't think anything is going to cause those spreads to widen out enough to hurt you in the long run, especially if you take at least a 12-month time horizon.

The trick with high-yield is to be invested, because you don't want to forgo that coupon -- especially if you think you're in an environment that is relatively stable, which I believe we are.

While you're invested, you obviously have to keep your eye on the possibility of that 1- and 10-year explosion that seems to come along for high-yield, whether it's an Asian currency crisis, or a Drexel Burnham going bankrupt, or just an outright recession. Right now I don't see anything on the immediate horizon that would make me back off, but you've got to be worried.

Is there anything else that investors should keep in mind about global high-yield?
Investors need to look at this asset class as broadly as possible and invest carefully. By carefully, I mean take more of an approach that an equity investor would take, which means don't just crunch ratios on these companies. Understand what the business of these companies is and how they're positioned.

Another thing I think many equity investors will do is recognize that you can be wrong, and always be quick to sell if something happens that contradicts your original thesis. It's important to define your market properly when you start out, and then bring an investing discipline.

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