Adam Peterson, CFA is one of four members of the Allianz Global Investors (AllianzGI) team that manages over USD 6.0 billion of assets in the SHORT DURATION HIGH INCOME fund. Mr. Peterson is part of the Allianz GI INCOME & GROWTH team, which has approximately USD 50 billion under management. On a recent visit to Latin America, he gave an exclusive interview to Funds Society. The investment manager, who has more than 20 years of industry experience, shared his views on the American economy, the sectors that offer the greatest investment opportunities and the outlook for low duration high-yield bonds in 2019.
The Allianz SHORT DURATION HIGH INCOME fund invests mainly in U.S. issuers whose revenue and income are derived primarily from operations in the domestic market. The investment team prioritizes capital preservation in its analysis of high yield bonds for the fund’s portfolio. In Mr. Peterson’s view, U.S. economic fundamentals are solid with expectations of growth around 2-2.5%, an unemployment rate of 4%, core inflation fluctuating between 1.5% and 2% and confidence indexes of consumers and companies remaining at fairly elevated levels. "The economy looks healthy and the fact that the Fed indicated it plans to pause or delay additional rate hikes in 2019 has caused equity markets to rise by approximately 10% so far this year," Mr. Peterson observes.
This same healthy environment has been apparent recently in the U.S. high-yield market. After the fourth quarter of 2018 when high-yield spreads widened considerably, January was the most positive month since October 2011. Spreads narrowed significantly and the high yield market has generated strong year-to-date returns above 5% thanks to "a significant decrease in market fears that the Fed would raise rates too aggressively," Peterson says.
The fund manager points to three reasons in particular that volatility in financial markets spiked towards the end of 2018: trade tensions between China and the U.S., the rise in interest rates and the slowdown in economic growth. In Mr. Peterson’s opinion, the one that most worries investors today is the US-China trade war and he affirms that, although President Trump is a clear defender of tariffs, there are several factors that are likely to mitigate his enthusiasm. "Many members of his cabinet advocate a more cooperative approach,” he notes.
“The loss of mid-term elections has weakened President Trump's position for aggressive negotiation when the Republican party does not control the House. He is becoming aware of the cost to the affected sectors." Mr. Peterson hopes that President Trump will try to buy time with a solution in the short term and that both countries will be able to reach an agreement with concessions on both sides.”
Reflecting on volatility expectations for 2019, Mr. Peterson is cautious but sanguine: “Volatility is most likely to remain above normal levels. However, we see the fundamentals of the American economy and the issuers in the high yield segment where we invest as extremely attractive.”
He explains that, thanks to the current strength of the American economy and a weakening of certain risk factors, most investment banks project default rates for the high yield segment during 2019 in the range of 1.5-3%. “That’s below the long-term averages that are between 3-3.5%,” he notes.
Although the SHORT DURATION HIGH INCOME fund invests in the high-yield segment, Mr. Peterson points out that given the team’s emphasis on capital preservation and focus on less cyclical companies with bond maturities of less than five years, he believes the strategy is actually a different asset than high yield. With a weighted average life (WAL) of 3.25-3.75 years and a target duration of 1.5-2 years, the fund aims to achieve the majority of the performance of the high-yield market with significantly lower volatility over the course of a full market cycle.
The shortened investment horizon is an important feature of the fund's strategy. By focusing on shorter-term issues in less cyclical companies, the SHORT DURATION HIGH INCOME FUND can significantly reduce interest rate risk while managing credit risk. According to Mr. Peterson, the fund has generated an attractive annualized return of close to 5% since 2009, the year of inception.
Mr. Peterson credits the portfolio’s performance to the fund’s investment strategy as well as the economic environment. "We prefer companies that are in less cyclical businesses with recurring revenue and high, stable margins,” he says. In addition, the portfolio managers focus on industries that are well positioned for an economic slowdown. He cites cable TV, wireless operators, alarm and home security companies as examples, adding that, in energy, the team prefers pipeline companies, “which are more dependent on volume than price," Peterson explains.
In a high turnover portfolio derived mainly from the early repayment of securities, the fund’s managers use a proprietary process that factors in 48 qualitative and quantitative variables to identify issuers with improving fundamentals and to select and monitor securities in the fund’s portfolio. Mr. Peterson describes the process that the team uses to develop a deep knowledge of the companies in which it invests. "We develop financial projections for five years, we analyze the history of the industry, how the company has behaved in times of recession, the sustainability of its competitive advantage, the quality of the management team and how the company intends to use the proceeds from the high yield issue. And that’s just one corner of our analysis!”
The SHORT DURATION HIGH INCOME fund has a balance of institutional and retail investors. Mr. Peterson reports that the fund has recently received significant inflows from investors in the U.S., Europe and Asia. It already has a significant number of clients in Japan. "The Japanese are known as conservative investors,” Mr. Peterson says. “In an environment of low interest rates where bond yields are low, they see the benefits of our strategy."
The content of this communication is not intended for the retail investor or for the wealth management professional who’s clients are residents of the U.S.
This is for guidance only and it is not a recommendation or investment advice to buy or sell any particular securities. Investing involves risk. The value of an investment and the income from it may fall as well as rise and investors might not get back the full amount invested. The volatility of fund unit/share prices may be increased or even strongly increased. Past performance is not a reliable indicator of future results. Investment funds may not be available for sale in all jurisdictions or to certain categories of investors. This is a marketing communication issued by Allianz Global Investors GmbH, www.allianzgi.com, an investment company with limited liability, incorporated in Germany, with its registered office at Bockenheimer Landstrasse 42-44, 60323 Frankfurt/M, authorised by BaFin (www.bafin.de).