Value, Growth and Hitting Home Runs
December 6, 1999
Although the Loomis Sayles High Yield Fund is relatively small, holding less than $20 million in assets since its inception in 1996, it consistently has ranked among the top performers in its class. According to Lipper Inc., the fund ranks 7th out of 334 mutual funds in its asset class year-to-date, with 12.54% returns. In 1998, it ranked 5th out of 302 funds, posting 21.03% returns.
And it has done so with an investment style that tends to go against the grain.
"Looking out across a broad high yield universe, we're looking for big home runs, and you usually find them where people aren't looking or where there's uncertainty," said Kathleen Gaffney, who co-manages the fund with Daniel Fuss.
The fund, which holds stakes in traditional high yield corporate issues as well as emerging markets debt and convertible securities, is not managed to an index or against average market weightings. About 20% of its holdings are in telecom and technology, while another 40% are in emerging markets. Of its emerging markets holdings, about 25% is invested in Asia, with the remainder in Latin America.
"Basically the approach is analogous to a value equity style, with us looking for bonds that offer good relative value within a sector," Gaffney said. "So they're cheap, but they've also got a good fundamental story supporting them."
In telecom and technology, Gaffney and Fuss search for credits with solid long-term prospects. These are companies with strong and experienced management teams and a competitive advantage, whether it is a deep-pocketed investor like Craig McCaw or Microsoft, or a telecom with a national footprint like Nextel.
The fund's telecom holdings are diversified, with primary investments in wireless operators and competitive local exchange carriers, along with some exposure to the digital subscriber line (DSL) sector and to some Internet service providers (ISPs). In addition to Nextel, RCN is one's of the fund's core telecom holdings.
Buying Amid the Uncertainty
Gaffney, however, doesn't put all her eggs in the value-investment-style basket. There also is room in the portfolio for a growth strategy. She has found "where the best opportunities are in terms of growth and momentum" by investing heavily in domestic convertible bonds from the semiconductor industry - names like Cypress Semiconductor, Lam Research and Integrated Devices.
Not only do these companies have a strong technological advantage, Gaffney said, but they also have kept the supply-demand ratio in balance. Here, the strategy is to buy these issues as bonds and sell them when the equity kicks in.
"Right now we're getting a little bit greedy in that we're holding them as they go through Treasurys and letting the equity run a little bit," Gaffney said. "Typically, we will start to pull back at that point and really try to take advantage of the liquidity flows in the market. We tend to be buyers when everyone else is uncertain, and when the perception changes, let go of them when the market is much more comfortable."
The same strategy characterizes Loomis Sayles' investments in emerging markets debt. Last year, the fund bought scores of Asian paper when the "market was pricing anything with an emerging markets name as if it was going out of business," Gaffney said.
Still, the fund did not take on any major credit risks, choosing infrastructure plays, banks, utilities, top-tier and blue chip industry names and telecoms to round out its emerging markets holdings.
"We manage for total returns, so it's important for us to have those attractive yields and have some discount built into the portfolio, so when perception on credit changes, we have a little bit of appreciation there," she said.
Still, over the last six months, Gaffney and Fuss have been paring back on their Asian holdings. After a period of illiquidity over the summer and emerging markets issues becoming increasingly difficult to trade, the fund has been more careful in selecting issues. A rising default rate, currently hovering near 6%, also has made Gaffney and Fuss nervous. The fund itself, however, has been barely scathed - running less than 1% on defaults, a fact that Gaffney credits to investing almost exclusively in single-B and double-B issues.
"We're more cautious about the issues we do buy because the markets are so thin, monitoring the holdings we do have, and at the margins, trying swaps from Asia to Latin America and within telecom," Gaffney said.
Even though issuance in the high yield market is slow and mutual funds have been hurt by weeks of cash outflows, Gaffney's outlook for the next six months is positive.
She will hold onto her energy positions, and select carefully within the healthcare sector, choosing hospital and managed care providers over long-term care facilities. The fund will also move more heavily into foreign commodity-based issuers and cyclical credits, given that the global economy is on the upswing and offshore investments present a significant cost advantage.
The Loomis Sayles High Yield Fund is marketed primarily to institutional investors, though it is open to retail investors.
(Editor's Note: The Loomis Sayles High Yield Fund is different from Loomis Sayles' larger New England High Income Fund, profiled in November in High Yield Report.)