Prudential Fund Wants More Cash, Less Cable
September 27, 1999
Prudential High Yield Fund, sold mostly to retail investors, has seen a few changes in 1999, mostly on the conservative side.
The fund, a flagship product of Prudential Investments, a unit of Prudential Insurance of America, has increased its level of cash and has opted to decrease its level of cable properties, generally one of the most popular items in a junk bond portfolio.
The cash position of the fund, normally around 2%, has increased to about 5%. In percentage terms that may not be eye-popping, but even 5% parlays into almost $200 million for the mammoth fund that has "just a shade under $4 billion," according to managing director George Edwards. Put another way, it has significantly more cash on hand than the average high yield fund has total assets (see chart on page 8).
So why all the cash, just sitting there and not being put to work? Like some other investors, Prudential is preparing itself for Y2K.
"We've become a little cautious over the past month or so, letting cash run up a little," Edwards said. "As hokey as it sounds, Y2K could increase our need for cash."
Any year-end cash crunch will likely be the simple culmination of cash outflows from recent weeks and the subsequent need to pay back the retail investor.
Aggregate cash outflows from mutual funds have been about $2 billion since the beginning of May, according to research firm AMG Data Services.
Reasonable Spot On The Credit Totem Pole
The other change in Prudential's high yield game is the decrease in cable holdings, usually a stalwart of junk bond portfolios.
Since the beginning of the year, Prudential has lowered its "heavy over-weight" in the cable sector to "market weight or slightly under-weight," Edwards said.
That's in keeping with Edwards' intense focus on single-B issues. He has decreased his exposure to cable issuers, among others, because cable, for the most part, is viewed as one of the safer junk industries and issuers are often rated BB, he said.
To be sure, cable is still the second-largest class of the Prudential High Yield Fund, accounting for 11.3% of the total assets as of June 30. But through mergers and acquisitions by larger, investment-grade companies, fewer and fewer of the high cable issuers fit the fund's single-B criteria.
The Prudential High Yield Fund has, as its primary goal, high current income, Edwards said, and the single-B issues give the fund the appropriate place in the issuers' capital structure, he said.
"[The single-B credit] allows us to take a reasonable part of the credit spectrum," he said.
Total return is important as well, of course, as long as it does not impede the goal of high current income.
In fact, the other eight funds in the Prudential family, which account for roughly $1 billion in assets, all have slightly different approaches with different appetites for riskier and/or safer investments.
As much as 70% of Edwards' assets are in the single-B category. Another 15% to 20% is in the BB category, and a small portion is at the CCC level. But the CCC notes he owns are only from issuers he considers underrated by the rest of the market - in other words, those that he believes should really be rated single-B.
And while Edwards focuses on the U.S. market, he sometimes ventures outside the border if the deal is good enough.
"We have some foreign exposure and a smattering of emerging markets," he said.
The small portion of the mix that is dedicated to foreign investments is mostly in the U.K. and Canada - with about 3% in emerging markets paper. And even that percentage is shrinking, he said.
The fund holds one major corporate issue from an emerging market country - which he did not name - and has operations in a number of countries, thus minimizing macro risks, he said.
Telecommunications is the biggest industry holding with 17.6% of the assets. Energy is third, after cable, with 6.6%, and media and healthcare round out the top five with 5.2% and 5%, respectively.
When it comes to specific issues, cable companies account for the two largest positions: Rogers Cable takes up 2.3% of the fund's assets and Cablevision soaks up another 2.1%. Rounding out the top five are AES (1.8%), Nextel Communications (1.6%), and California Federal (which is a preferred stock deal and accounts for 1.2% of the funds).
Value To Be Found
Even though the fund has sold off some of its cable holdings recently, Edwards said that he expects the sector to provide some value over the next three to six months.
While defaults are up a little, he maintains that value is there to be had. "Our view is that fundamentals are good and spreads are wide," he said.
Right now, typical spreads in the single-B category that the fund craves are about 570 to 610 basis points over Treasurys. And underlying all of that is an expanding economy, he said.
Prudential Investments has a total of $10 billion in high yield assets. In addition to the $4 billion Prudential High Yield Fund and the family of other funds with a combined $1 billion, the company has another $5 billion in insurance and third-party managed assets in the high yield market.