Bowling with bumpers

Brad Benson's picture

On this my second blog post and going forward, I intend to share a little of how the High Yield Bond Team thinks about the investing process and how we look at current events. As Kamyar has spoken to in an earlier post, credit selection is a key driver of outperformance and this is especially so for high yield where companies typically have more leverage and feel the effects of poor earnings more acutely. A truism that we’ve talked about at length with clients is that outperformance in high yield relies a great deal upon avoiding defaults, also known as a permanent impairment of capital. Another concept that we’ve talked about is the 4 C’s of credit evaluation: Covenants, Capacity to Repay, Collateral and Character. The intersection of Character and loss avoidance is what I’d like to talk about today.

A new study by Moody’s this past week highlighted the default experience for various private equity shops. New private equity deals, or leveraged buyouts, are a significant source of new and existing product for our market and we aim to partner with sponsors who are responsible equity stewards. This study however highlights two sponsors who stand out as having over twice the rate of default incurrence, relative to their peer average. The two firms in question are: Cerberus – a firm which is named after the three-headed dog guarding the gates of hell, and Apollo – a firm which routinely engages in coercive debt exchanges and aggressive deal structuring. While I wouldn’t go so far as to say we would never buy one of their deals, I would say it is a rarity for us to even look at one and we’ve been well served by not lending to them. We have many bond deals we can evaluate in a given week and anything that helps narrow this funnel of ideas to investable ones helps with our investing success. I think of this bias as bowling with bumpers. If you’ve ever been bowling with your kids, it is helpful to pick the lane with those little rubber bumpers to keep the ball rolling down the center of the lane.

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