DDJ Capital Management Blog

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.

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.

DDJ Capital Management recently recorded an audio market update with Sameer Bhalla, Senior Research Analyst with 16 years of industry experience in the Energy space, to provide an update on the crash in oil prices and its implications for energy companies within the high yield universe.

One of the subjects that Mr. Bhalla and his co-host Stacy Havener, Founder & CEO from Havener Capital Partners, discussed was West Texas Intermediate (WTI) oil prices recently turning negative and the factors that led to this unprecedented development. Below is an excerpt from their conversation:

“On the supply side, the supply continues to come on. If you have oil and gas wells that are producing today, you can't immediately shut those off. Those take time to run off, and wells that were drilled a month ago will continue to come online and produce in the high level, so what you've seen is this imbalance between production that continues to increase – these volumes that continue to increase – plus the supply actions that OPEC took in March to increase their production by four to five million barrels, and then you have the demand loss. So, the numbers are staggering and basically unprecedented.

DDJ Capital Management recently recorded an audio market update with firm founder, Portfolio Manager and CIO David Breazzano to discuss the extreme volatility and liquidity challenges in the high yield market. A question was asked about where the team is currently finding strong risk-adjusted investment opportunities.

Listen to Mr. Breazzano’s response. 

DDJ Capital Management recently recorded an audio market update with firm Founder, Portfolio Manager and CIO David Breazzano to discuss the extreme volatility and liquidity challenges in the high yield market. A question was asked about the downgrading of BBB-rated bonds (aka “fallen angels”) into the non-investment grade universe and what kinds of disruptions and opportunities this activity will create.

Listen to Mr. Breazzano’s response from the call on March 27, 2020. 

There are many potential benefits of including a dedicated high yield portfolio as part of a long-term asset allocation, including improving its risk-adjusted-return profile, increasing diversification, and providing a consistent source of meaningful cash generation. In addition, as we discuss below, we believe that the high yield market (comprising both high yield bonds and bank loans) has structural inefficiencies that can be exploited through rigorous, bottom-up fundamental research and a risk management process focused on minimizing credit losses. Our view is that high yield is an asset class in which a skilled active manager can generate significant and sustainable outperformance over the long-term.

As displayed in the chart below, the high yield market, as represented by the ICE BofA U.S. High Yield Index, has generated impressive returns over the last 30-years with significantly less volatility than equities.