Although Ben Trosky, managing director and portfolio manager at Newport Beach , Calif.-based Pimco believes the high yield market finally offers some good value, his top down-oriented firm is nonetheless defensive and will continue on that track going forward.
Last year, Pimco's High Yield Fund outperformed the Lipper Index by 1.88%. And in the last three years, while the Lipper Index average was 2.56%, Pimco's was at 5.08% after fees and expenses.
The top down process sets a backdrop for the risk environment of the market, Trosky said. For example, during periods where Pimco is less sanguine towards economic process, or sees exogenous risk factors as having a higher probability of impacting the marketplace, the portfolio is usually adjusted to a more conservative posture than under normal circumstances. And although the high yield fund buys the most aggressive B3/B-minus rated credits, it is usually managed to a double-B average credit quality. It can and frequently does buy single-B rated credits, but is restricted from buying triple-C rated securities by prospectus.
"The triple-C sector alone represents anywhere from one- to eight percent of the high yield market, depending on the benchmark chosen. The high yield market and aggregate is closer to the single-B average quality. If the market overall is mostly single-B, we're definitely higher than average," Trosky said.
But Pimco is by no means a closet indexer, Trosky said. There are entire sectors the fund excludes from its portfolios because of poor risk characteristics. For example, Trosky does not hold retail credits because, he said, consumer spending has outpaced income for a long time and consumer debt levels too have risen sharply. And the Internet has also impacted the retailing sector. "We cannot find any credits that are positioned to offset those trends, so we don't own retail credits in the portfolio," Trosky said.
His top five industry exposures include weightings of 7.9% in cable, 11.1% in telecom, 7.6% in finance companies, 4.1% in chemical and 3.7% in publishing. Trosky declined to disclose specific names held in his portfolio.
Because Pimco is underweighted in the telecom sector, the fund's performance year-to-date is lagging in the overall universe of high yield. Still, this will not meaningfully change the fund's investment strategy, Trosky said.
"A lot of the bonds issued in telecoms are pseudo-capital equity ventures and poor collateral values," said David Hinman, senior vice president and manager of Pimco high yield products, who works with Trosky. "There is also rapid product obsolescence." He also noted that it is Pimco's policy to have a higher quality bent on double-B bonds. "We feel we can take less risk than our competitors and produce better performance."
Trosky also avoids heavy cyclicals such as steel. "The risk returns are fairly unattractive," he said. And he maintains the same policy on technology, which he said he does not own. "The idea of making a 10-year sub loan to a company that has an 18-24 month product cycle strikes us as a mismatch between assets and liabilities and poor risk return tradeoffs."
He did say, however, that about 1.5% of the fund is in emerging markets. Smaller positions include investments in Japanese banks, and roughly 3% in European credits. "We have a broadly diversified portfolio with relatively stable demand characteristics and identifiable cash flow profiles that should be resistant to economic downturns," he said.
As for the next 12 months, Trosky sees bond issues yielding between 8% and 10%, which, he says, may compare favorably to equities in the years going forward. In the meantime, He is focusing investments in seven-year notes whenever possible versus those with 10-year maturity dates. "So, it's a pretty conservative portfolio," he said.
Trosky has spent roughly 20 years in investment management and joined Pimco in 1990 after working as analyst and then co-manager of high yield mutual funds at Merrill Lynch Asset Management for four years.
Of Pimco's roughly $195 billion in fixed income assets, the fund has about $9.5 billion dedicated to high yield in specialty mandates.
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