When many investors hear terms like “default” or “bankruptcy”, negativity and losses probably come to mind, and for good reason. Over the past 25 years, on average, when a high yield bond has defaulted, investors lost almost 60 cents on every dollar invested.1
“Rule 144A is therefore very valuable to issuers, as it reduced the cost of capital by improving the liquidity of the institutional secondary market for privately placed bonds.”
– Andrew Ross, CFA, Director, Portfolio Specialist
Not familiar with 144A bonds? You’re not alone. Given the growth of bonds issued via Rule 144A (“the Rule”) and their increased importance in the high yield market, we thought it would be informative to provide a brief overview of Rule 144A and the bonds issued under this rule.
Today we are very happy to announce the winners of the DDJ Capital Management White Paper Challenge. In this contest, college students were tasked with submitting a paper discussing the topic: “Does Board Diversity Impact Corporate Performance?” Of all the contestants, we have selected the following two winners.
Now that the U.S. economy is officially in a recession, what is the state of corporate credit quality? During a recent discussion with the CFA Society of New York, DDJ President, Chief Investment Officer and Portfolio Manager David Breazzano offered his opinion on the subject:
It's a very interesting question. And I'd like to answer it in a couple of different ways. One, the short answer is corporate credit quality certainly has declined as a consequence of the current recession. However, to understand this, it is necessary to look “under the hood” of the high yield market and dig into some of the statistics. If one were to look at the credit quality of a broad high yield bond index, it would show that BBs have actually increased as a percentage of the overall index since the start of the year, whereas Bs and CCCs have declined. So, at a statistical first blush, one would look at it and say, "Wow, credit quality actually has improved this year."
The market’s perception of the current state of the pandemic can change quickly and result in heightened volatility. For example, the perception that certain states may have opened too soon or that a second wave of the virus is imminent, and thus economic pullbacks are on the horizon, can increase market volatility significantly. Such changes in perception are often driven by the latest headlines, which can be misleading and therefore do not represent reality.
As prudent investors, we need to filter out the day-to-day noise and focus on the factors that will determine whether the economic reopening can continue or broad pullbacks will be needed in certain areas. In this regard, I believe that the most important factor to monitor in a specific region is hospital capacity utilization resulting from COVID-19 patients, in particular ICU bed capacity. Fatalities are of course the most important metric that we as a society must strive to minimize; however, fatalities typically rise after an increase in ICU beds and ventilator usage, and will thus lag changes in hospital capacity.
Since we launched our blog last September, we have received a lot of positive support. We sincerely appreciate you taking time out of your day to read our thoughts on the market.
Below, we have highlighted our three most popular blog posts from 2020 to date. Two of our most read blogs this year came from our special Week in Review series during March when the market was unraveling. We’re happy to be able to provide perspective when investors need it most. See which ones made the top 3 list.
If you have a topic you would like for us to cover, please contact us. We appreciate your feedback.
The DDJ Investment Team
Do you know a college student or incoming freshman whose summer plans have been impacted by recent events?
Events around the world have had a profound effect on all of us at DDJ Capital Management, as well as our clients, industry colleagues and students who are interested in pursuing opportunities in the financial markets. As stewards of our clients’ assets, we seek to prudently invest in order to generate strong risk adjusted returns, and as citizens in the financial services industry, we seek to invest in college students, who will be the future of our industry.
As we continue to hear repeated stories of students losing their internships with financial services companies globally, we at DDJ thought about what we could do to help. While we can’t replace these lost internships and the critical experiences they provide, we can try to create other opportunities and experiences. To that end, we are announcing the DDJ Capital Management White Paper Challenge.
This White Paper Challenge is a writing contest for undergraduate college students interested in financial services. Each student will submit a paper discussing the topic: “Does Board Diversity Impact Corporate Performance?” This opportunity is to encourage college-aged students to explore the issues of diversity as they relate to corporate operations and success.
In our view, the current environment is more similar to that which occurred during the Global Financial Crisis (“GFC”) of 2008-2009 or the dot-com bubble of 2002-2003 than the oil price driven sell-off during the second half of 2015. In light of this perspective, we analyzed how the quality rating segments of the high yield market performed, beginning just prior to those two historical drawdown periods and continuing as the economic recovery ensued. Using the ICE BofA US High Yield Index as a proxy, Charts 1 and 2 below display the cumulative growth of $1 invested in each quality segment of the high yield market at the beginning of the quarter in which the GFC and dot-com bubble selloff occurred, respectively.
Of all the misconceptions regarding the CCC-rated segment of the high yield market, DDJ believes one of the most common is that all CCC-rated bonds have essentially the same level of risk.
One of the core tenants of DDJ’s investment philosophy is that the CCC-rated segment is one of the most inefficient of the high yield market. Why is this segment inefficient? We believe that it is due in part to the misconception listed above. As a result of the perceived riskiness of the CCC-rated segment, investment guidelines for many high yield portfolios commonly restrict or prohibit CCC-rated holdings, resulting in the CCC-rated segment of the high yield market being less researched relative to higher quality segments. In simple terms, fewer investors targeting this area of the market results in less efficient pricing and a slower incorporation of new data/events into market prices.
In a recent Q&A conducted with our Portfolio Managers, the question was posed:
“Are there any aspects of your investment team or process that you might not find at traditional high yield managers, but you believe contribute to your success?”
While there are many aspects of our investment team and process that we believe offer DDJ competitive advantages, one that we like to highlight is our in-house legal expertise.