High Yield Fund (HWHIX)

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The performance data quoted represents past performance and does not guarantee future results. Current performance may be lower or higher. Investment return and principal value of the fund will fluctuate, and shares may be worth more or less than their original cost when redeemed. Click quarter-end or month-end to obtain the most recent fund performance. The High Yield Fund imposes a 2.00% redemption fee on shares held for 90 days or less. Performance data does not reflect the redemption fee. If it had, return would be reduced.

Manager Commentary
Period ended June 30, 2019

 
MARKET COMMENTARY

The ICE BofAML US High Yield Index returned +2.6% in the second quarter of 2019 and is now up +10.2% since the beginning of the year.  An increasingly dovish tone from the US Federal Reserve contributed to a positive high yield market, as Chairman Jay Powell indicated a readiness to lower interest rates for the first time in more than a decade. The Federal Funds futures market is pricing in a high likelihood of a rate cut during the Fed’s next meeting, and both long and short term rates fell accordingly.  The very short end of the yield curve remains inverted, but the 2/10 year curve is upward sloping and steepened further during the quarter.  The yield-to-worst (YTW) for investment grade (ICE BofAML US Corporate Index) and high yield credits (ICE BofAML US High Yield Index) declined 0.5% and 0.4%, respectively.  Spreads remained remarkably stable during the quarter.  Two notable exceptions to the modest decline in yields and stagnant spreads were CCC-rated bonds and the energy sector, which are not mutually exclusive.  The lowest rated high yield cohort returned just +0.6% in the quarter, lagging the index by 2 percentage points, as its YTW increased slightly and its spread over treasuries widened by about 60 basis points.  High yield energy credits returned -0.8% in the quarter, with energy YTW increasing by 0.2% and spreads widening by more than 70 basis points. 

Geopolitical tensions seemed to subside, as the US reached a deal with Mexico to halt proposed tariffs, and US-China trade talks resumed, buoying markets further.  All sectors except energy (-0.8%) were positive in the quarter, with insurance, retail, transportation, and banking leading the way.  The high yield default environment remains benign relative to average.  The default rate, including distressed exchanges, is 1.55% which is less than half of the 20-year average.  This is down 0.34% since the beginning of the year and down 0.50% year-over-year.  During the first half of 2019, 13 high yield bonds defaulted and 2 went through a distressed exchanged, for a total par value of about $14 billion ($8 billion occurred during the second quarter).  The market’s average post-default recovery rate stands at 36%, slightly less than the long-term average of 41%.  This is a bit misleading, however, considering that defaults have been few and far between.  About one-third of this year’s default activity was in the energy sector.  Less than 1% of the market trades for under 50% of par value and less than 5% trades for under 70% of par value, reflecting the market’s view that fundamentals remain sound. 

The new issue market has picked up from 2018’s slowdown, and remains on a pace slightly lighter than average for the past decade.  About two-thirds of all issuance has been for refinancing and less than 20% for LBO/acquisition activity.  Just 10% of new issuance was CCC-rated debt and more than two-thirds of that was for refinancing. 

Overall, our view of the high yield market remains relatively unchanged.  Fundamentals are solid and the new issue market well-behaved, which appears to be appropriately reflected in valuations.  We maintain our focus across high yield credits of all sizes, which has helped facilitate a ~75 basis point spread advantage relative to the broad benchmark and we remain optimistic about the portfolio’s prospects going forward.    

ATTRIBUTION: 2Q 2019

The Hotchkis & Wiley High Yield Fund underperformed the ICE BofAML US High Yield Index and ICE BofAML BB-B US High Yield Constrained Index in the second quarter.  The portfolio’s overweight in small and mid cap credits was a performance detractor in the quarter as larger cap credits outperformed.  Credit selection in basic industry and consumer goods also hurt relative performance, along with the underweight allocation to telecommunications.  Positive credit selection in the automotive, capital goods, and energy sectors helped relative performance in the quarter.

OUTLOOK (Scoring Scale: 1 = Very Negative . . . . 5 = Very Positive)

Fundamentals (3): No change.  Defaults remain well below average.  We expect a benign environment to continue because leverage remains in check and because revenue and earnings are reasonable.  Trade war potential keeps the score from rising further, which has the potential to impede economic growth and therefore affect revenue and earnings growth.

Technicals (4): Increased from 3 to 4.  The new issue market remains about average and asset class fund flows are strong.  There is also strong call and tender activity and overall market liquidity remains decent.

Valuation (3): No change.  Valuations remains appropriate considering the market’s decreased leverage and overall health.  The excess spread, or spread adjusted for unrecovered defaults, remains stable.

Mutual fund investing involves risk. Principal loss is possible.  Investments in debt securities typically decrease in value when interest rates rise. This risk is usually greater for longer-term debt securities. Investment by the Fund in lower-rated and non-rated securities presents a greater risk of loss to principal and interest than higher-rated securities. The Fund may invest in derivative securities, which derive their performance from the performance of an underlying asset, index, interest rate or currency exchange rate. Derivatives can be volatile and involve various types and degrees of risks. Depending on the characteristics of the particular derivative, it could become illiquid. Investment in Asset Backed and Mortgage Backed Securities include additional risks that investors should be aware of such as credit risk, prepayment risk, possible illiquidity and default, as well as increased susceptibility to adverse economic developments. The Fund may invest in foreign as well as emerging markets which involve greater volatility and political, economic and currency risks and differences in accounting methods.

Fund holdings and/or sector allocations are subject to change and are not buy/sell recommendations. Current and future portfolio holdings are subject to risk. Portfolio managers’ opinions and data included in this commentary are as of 6/30/19 and are subject to change without notice.  Any forecasts made cannot be guaranteed.  Information obtained from independent sources is considered reliable, but H&W cannot guarantee its accuracy or completeness. Portfolio’s absolute performance may reflect different results. The Fund may not continue to hold the securities mentioned and the Advisor has no obligation to disclose purchases or sales of these securities. Attribution is an analysis of the portfolio's return relative to a selected benchmark, is calculated using trade information and does not reflect the payment of transaction costs, fees and expenses of the Fund. 

Credit Quality weights by rating were derived from the highest bond rating as determined by S&P, Moody's or Fitch. Bond ratings are grades given to bonds that indicate their credit quality as determined by private independent rating services such as Standard & Poor's, Moody's and Fitch. These firms evaluate a bond issuer's financial strength, or its ability to pay a bond's principal and interest in a timely fashion. Ratings are expressed as letters ranging from 'AAA', which is the highest grade, to 'D', which is the lowest grade. In limited situations when none of the three rating agencies have issued a formal rating, the Advisor will classify the security as nonrated.

Investing in high yield securities is subject to certain risks, including market, credit, liquidity, issuer, interest-rate, inflation, and derivatives risks.  Lower-rated and non-rated securities involve greater risk than higher-rated securities.  High yield bonds and other asset classes have different risk-return profiles, which should be considered when investing.  All investments contain risk and may lose value.

The ICE BofAML index data referenced is the property of ICE Data Indices, LLC (“ICE BofAML”) and/or its licensors and has been licensed for use by Hotchkis & Wiley. ICE BofAML and its licensors accept no liability in connection with its use. See Index definitions for full disclaimer.

The average annual total returns for the ICE BofAML US High Yield Index were 2.56%, 7.58%, 7.54%, 4.70%, 9.22% and 11.22% for 2Q19, one-year, three-year, five-year, ten-year and Since 3/31/09 periods ended June 30, 2019.
 

Index definitions

Glossary of financial terms