David Brezzano co-founded Polen Capital Credit in 1996 and has over 41 years of experience in high yield, distressed and special situations investing. At Polen Capital Credit he leads the investment team and chairs the Investment Review Committee. Mr. Breazzano also sits on the Operations Committee of Polen Capital Management (the parent company of Polen Capital Credit).
Russ Alan Prince: Can you tell us more about Poland Capital Credit and where can you find income in the current environment?
David Brezzano: Poland Capital Credit, formerly known as DDJ Capital Management, is a firm I founded in 1996 with the aim of investing in the high yield bond and leveraged loan markets, or what is now collectively referred to as the leveraged credit market. Before founding the company, I was a high yield portfolio manager at both Fidelity and T. Rowe Price. There I observed certain inefficiencies in the leveraged credit market that larger investors failed to take advantage of.
For over 25 years, Polen Capital Credit has applied the same rigorous bottom-up fundamental and legal analysis to uncover attractive investment opportunities for our client portfolios in what we have found to be the most inefficient area of the high yield market, namely, the downside.
At Polen Credit, we build concentrated portfolios position by position to seek a yield or income advantage over the broader leveraged lending market. We look for high-quality companies that can generate a steady cash flow to service their debt. Once we identify an asset with these characteristics, we tend to buy and hold, taking fewer but larger positions relative to our competitors. The result for our clients is a portfolio that benefits over the long term from the compounding effect of the income from these investments.
One of the key differentiators of our investment strategies is the flexibility to invest across asset classes within the leveraged credit market. This flexibility has proven invaluable to the success of our strategies and serves our clients well in the current environment.
Today, several “macro” factors such as inflation and rising interest rates – not to mention the dire situation in Ukraine – have led to significant volatility in the leveraged credit market. This volatility has created an opportunity to add to existing positions and selectively initiate new investments in both high yield and leveraged loans.
prince: How can high yield investing be a good idea in a rising interest rate environment?
Breazzano: Because credit spreads, or the premium for taking credit risk, tend to decrease when interest rates rise, high yield has traditionally provided a hedge against a rise in interest rates by tightening spreads. In addition, these bonds generally have shorter maturities and higher coupons than investment grade bonds and therefore have a much shorter average duration. As a result, high yield bonds have performed well in rising interest rate environments. However, not all high yield bonds are created equal, and a closer look at the market reveals that some bonds are performing better than others.
High yield market data shows that the lower tier, particularly CCC rated bonds, can provide a significant hedge against rising interest rates relative to their higher rated peers. Rising interest rates typically reflect improving economic conditions, which is particularly beneficial to the creditworthiness of CCC-rated issuers, which are often the most credit-sensitive in the high yield market. On the other hand, BB-rated bonds, which do not offer the same credit risk premium as CCC-rated bonds, tend to be more interest-rate sensitive due to their higher quality, being “nearly” investment grade creditworthiness. As a result, their spreads tend not to tighten as much and thus do not compensate for the rise in interest rates to the same extent as their lower-rated peers.
However, the CCC-rated segment of the high yield market requires careful analysis of each individual loan to avoid the historical default losses that this cohort most often experiences at the end of the credit cycle. Therefore, given Polen Credit’s expertise and experience in finding higher yield opportunities in the CCC-rated segment of the high yield market, we believe we can offer our clients an added benefit in the form of natural interest rate hedging. Importantly, this natural hedging benefits our client’s overall fixed income allocation without exposing the client to undue credit risk.
prince: While both high-yield bonds and senior bank loans are attractive due to their relatively higher income-generating qualities, what is more compelling today?
Breazzano: As I mentioned, the flexibility to invest in both high yield and leveraged loans within our client portfolios is a key differentiator of our investment strategies. Our research process is designed to identify the best risk-reward opportunities, whether they come in the form of a high yield bond that pays a fixed coupon or a leveraged loan that pays variable coupon payments that are higher or lower will be reset to prevailing rates.
However, we do not make portfolio asset allocation decisions based on the relative value between the broad high yield and leveraged loan markets. Rather, we use our customers’ flexibility to identify the most attractive investments item by item. Ultimately, our client portfolios benefit from our ability to allocate bonds and loans based on their relative attractiveness, enabling us to offer clients value based on changing market opportunities throughout a credit cycle.
Against this background, the sell-off at the beginning of the year was initially driven by fears of inflation and rising interest rates. These fears disproportionately weighed on the highest quality segment of the high yield market, which, as I mentioned, tends to be more sensitive to rate hikes. Conversely, leveraged loans are much less interest rate sensitive and outperformed for the reasons outlined above.
As Ukraine’s devastating war unfolded, concerns about its impact on global growth and supply chains, coupled with heightened geopolitical uncertainty, have led to a broader “risk-a” mentality that eventually seeped into the leveraged loan market , albeit on a much smaller scale. During this time we reduced our allocation to certain leveraged loan positions and added higher yielding bonds to our portfolios accordingly. We make these investments in companies that our analysis shows are stable, well positioned to weather the current market uncertainty and offering very attractive yields. Through these actions, as Polen Capital’s fourth and newest investment franchise, we remain committed to fulfilling the company’s mission of preserving and growing client wealth to protect their present and enable their future.
RUSS ALAN PRINCE is Executive Director of Private Wealth Magazine (pw-mag.com) and one of the foremost authorities on the private wealth industry. He advises family offices, wealthy, fast-moving entrepreneurs and selected professionals. Connect with him on LinkedIn.com.
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