Zenith Portfolio Strategies High Yield Brief

This may help frame the discussion for your next investment committee meeting as you determine the appropriateness of high yield debt in your portfolio.

Pros

• Low default rate is projected to continue as issuers have taken advantage of low yields to refinance and to extend maturity. 75% of the Credit Suisse HY Index bonds come due in 2017-2021.
• The Fed Taper numbers for employment and inflation do not warrant an immediate reduction of asset purchases and they have guided that short term rates should be low into mid-2015.
• High Yield has held up well and is positive for the year as credit has generally done better than the Treasury heavy Barclays Aggregate Index
• High Yield has a yield of about 6%.
• Reasonably strong corporate fundamentals support continued issuer payments.

Cons

• Corporate fundamentals can deteriorate quite rapidly, pressuring high yield bonds.
• The wall of maturities will become an issue in a couple years.
• The “perfect storm” can develop if the fundamentals deteriorate at the same time as maturities become imminent.
• At that point, instead of market price risk and volatility, the investor is faced with the real possibility of an increase in defaults.
• Bonds of companies that are perceived to be heading toward default trade at prices much lower than they enjoy while default risk is pushed into the future.
• The aggregate price of the high yield universe is higher than the historical average of 92 cents on the dollar hovering around par or above.

We feel that this asset class has benefited from a number of factors including the low rate environment that has helped the corporations and forced a lot of investors into higher yielding securities as a reach for income.

While high yield is not likely to implode, this asset is at best reasonably valued and in most cases richly priced. However, there are pockets of this market that continue to offer value and we recommend utilizing a mutual fund vs. an ETF for a few reasons.

We look for a manager that possesses a defined strategy compared to a passive approach.

I-Shares i-Boxx $ High Yield Corporate Bond ETF HYG-

This ETF will provide passive exposure to this asset class at a reasonable fee and will mirror the overall high yield market decently although we prefer to have the main risks and opportunities in below investment grade debt managed.

Our manager search given our criteria yielded two managers with one or all of these characteristics.

 volatility that is less than the ETF listed above
 less decline during the May/June sell-off than HYG
 lower aggregate price of the portfolio compared to most high yield indexes
 higher yield
 greater alpha producing system such as through substantial credit research
 duration management

We recommend that you take the time to vet your current high yield exposure and to re familiarize your teams insight into your managers defined strategy. Also, if your current exposure is with an ETF, consider a manager with superior metrics and who has a plan when the credit conditions are not so good.

Sincerely,

Tom Koehler-CIO

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