Opportunistic and Selective in High Yields
Artisan High Income Fund
Bryan C. Krug
Author: Ticker Magazine
Last Update: Mar 01, 11:56 AM ET
|An active investment approach can only benefit from market inefficiencies, according to Bryan Krug, portfolio manager of the Artisan High Income Fund. The management team looks for strong business models where a credit improvement is expected over time. A key part of the fund’s strategy is identifying value across the entire capital structure with the help of extensive credit research.
“We are research intensive and rely on our core names, which are stable, predictable businesses. But when there are market inefficiencies, we are willing to make material investments in opportunistic buckets.”
In addition to myself, our team consists of five analysts. We have a generalist approach to research with sector tendencies. One of our analysts covers the consumer vertical, which includes consumer products, retail and gaming. Another analyst covers telecoms, media and technology. The third analyst is responsible for basic industries, including home building, building products, paper, packaging and industrials. The fourth analyst covers the commodity verticals, which means energy, metals and mining. And the fifth analyst does healthcare, utilities and chemicals.
Currently, I handle banking, business, insurance and financial services, but eventually the analyst who covers basic industries, will take responsibility for that as well.
Q: How do you make your investment decisions?
We meet on a regular basis—twice a day, every day. First we meet in the morning to go through the movers of the day and to discuss each sector. We also meet at a research lunch, when we have an in-depth discussion of new ideas, updates on existing positions, an overview and relative value discussion on the existing and potential investments.
Ultimately, I am responsible for what goes in and out of the portfolio. I listen to and use the input of the analysts, but I am the final decision maker for the portfolio.
Q: Could you explain the portfolio construction process?
The portfolio consists of core holdings, spread tightening and opportunistic investments. The core part of the portfolio represents high-quality companies. Spread-tightening means that we expect to have material credit improvement in trading with a relatively wide yield. The opportunistic bucket is based on technical market parameters and, essentially, is an event-driven play.
The core bucket typically represents 20% to 60% of the portfolio, spread tightening accounts for 10% to 50% of the portfolio, and our opportunistic exposure is limited to 10% to 30% of the portfolio.
We aim to take advantage of different risk profiles. In the core segment, there are plenty of opportunities to make money on improving credit. In spread tightening, we have a longer-term expectation for credit improvement, while in the opportunistic, event-driven names, we try to take advantage of market technicals.
In terms of industries, we have significant over-exposure to software, technology and insurance brokerage. We have material underweights to cyclical industries like metals and mining. Currently, we have 77 issuers.
Q: How important is the benchmark for your portfolio construction process?
Our benchmark is the Bank of America-Merrill Lynch US High Yield Master II Index, but we don’t follow it closely. We are not afraid to be materially underweight or overweight in any particular sector. In certain periods, we may have large exposure to software, services and insurance brokerage. Conversely, we have material underweights in other areas such as metals, mining or cyclicals.
Our exposure mostly depends on our fundamental view, so we are benchmark agnostic. We tend to have higher conviction in our names.
In terms of diversification, we have high-conviction positions, and there is a potential tracking error from the indexes because of the way we manage.
Right now, about 38% of the portfolio is in our top 10 issuers. We don’t have specific sector limits. I am comfortable with where we are and I wouldn’t expect the portfolio to become more concentrated from a sector perspective.
Q: What is your biggest risk and how do you control it?
We believe the biggest risk for the portfolio is credit risk, so we make sure a particular asset class has an asymmetric risk profile.
To avoid permanent loss of capital, we are really careful about making sure we get the right business quality, in the right stable businesses, which can handle the developments in their area.
Many of our peers tend to invest in more cyclical businesses, such as commodities, while our focus leads to higher predictable recurring revenue models. Overall, we worry more about credit improvement than about rate revision.
Q: Do you have your own internal ratings system?
We don’t have official internal ratings. We know what the ratings of rating agencies are, but we may agree or disagree with them. Frankly, our process tends to identify situations in which companies are underrated by the agencies because of their current high leverage, but we recognize the value of the security because of our fundamental credit research.
Ironically, the agencies tend to put a lot of value on hard assets. As a result, some commodities businesses like energy exploration & production are actually given higher ratings than their volatility would have dictated over the last years.
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