Question: The performance in most sectors of the bond market was very strong at the end of 2023, despite a lot of volatility. What do you see for 2024?
Jordan Lopez: Much of the 2024 performance was pulled forward in November and December, but all else equal, we expect 2024 to be another good year. There are a lot of macro tailwinds that should support all risk assets, but particularly high-yield bonds. High yield bonds benefit from growth in general, and as inflation comes down – which we believe it will – rates should rally to the benefit of high yield bonds. In some ways, it's the best of all worlds. Our base case now is for a soft landing. We believe unemployment will remain low, growth will remain positive, albeit maybe not as positive as it was last year, and inflation will continue to trend down.
When we look at the makeup of the high yield market specifically, it's still very healthy. The valuations aren't quite as attractive as they were a few months ago, but with all-in yields at 8%, that's competitive with equities long-term, and historically, high yield has much better downside protection than broad equities do. With that as a backdrop, we do expect money to keep flowing into the asset class and we expect the companies within high yield to continue to perform.
Nick Burns: One of the themes everybody talks about is the macro-economic environment, and that's obviously very important, but the micro economic perspective is important too. We've seen persistently positive results in terms of issuers continuing to maintain balanced balance sheets and balanced credit metrics, with overall fundamentals that suggest that they are prepared to manage through a recession. I don't think a recession is anybody's base case at this point but you still have a lot of comfort with the margin of safety that you're getting from the issuers in our universe.
Valuations are not necessarily as interesting as they may have been a few months ago, but it could be that the market's not completely wrong to value these companies where they're valuing them, given the robust macro tailwinds that we've seen and that margin of safety that they've been able to build in at the micro level.
Question: Is there anything that keeps you up at night? What could go wrong here?
Jordan Lopez: The biggest risk to all asset classes is a reacceleration of inflation. If that were to happen, hopefully it wouldn't be quite as painful as 2022 because we're starting from a higher base, but it would certainly be negative for both rates and risk assets. We have a fair amount of confidence that we're going to continue to trend lower in inflation, or at least hold where we've been for the last several months, but I think that is probably the biggest risk to markets at this point. Of course, there are always unknown risks, but I would say that's the biggest known risk at this point.
Question: What about geopolitical risks? And the election's coming up. Do you see the election having any big impact here?
Jordan Lopez: Those factors don’t directly affect our asset class which is a pretty US-centric asset class.
Certainly, strange things can happen, and it will be a very interesting year for politics. As far as geopolitical risk goes, one of the points that often gets overlooked is geopolitical risk has impacted high yield in the past because of its impact on oil prices. But over the last several years, as the U.S. has become the swing producer of oil, we're somewhat more insulated from geopolitical risk shocking oil higher and lower. That's not to say it can't happen, but I think that's become a lot less of a risk just as the U.S. has increased its production in both oil and natural gas.
Question: What sectors within the high yield are you finding attractive and what are you avoiding?
Nick Burns: As a matter of strategy, our preference is to think about our portfolio construction from the issuer level up. To the extent that we can, we try to neutralize our deviations from index sector levels. There are sector biases that manifest themselves as a result of our bottom-up calls, but we're not expecting them necessarily to be a big driver of performance because we think those are difficult calls to make.
At the margin, we've seen some more attractive value in some of the auto parts manufacturers. There's been a lot of negative sentiment in the auto sector, with inflation having impacted autos the most. And recall, back in 2021 and 2022, the supply chain issues that were having a big impact on original equipment manufacturers (OEMs) and overall auto production. So we're able to invest in pretty attractive names at really interesting levels. That's showed up as a modest overweight.
As far as underweights go, we've been slightly underweighting the gaming sector in leisure, as well as the cruise line sector. That's largely a relative value call because there's a lot of solid companies in those segments, and you're not really getting paid for some of the consumer cyclicality that you often see in those sectors. That's been a relatively easy place to go modestly underweight for us. But thematically, I wouldn't say that we have any dramatic sector themes built into the portfolio right now.
Jordan Lopez: And that's by design.
Question: How do bond ratings impact your security selection?
Jordan Lopez: We’re somewhat ratings agnostic. We're very much relative value driven, no matter where the ratings are. In general, I think we tend to be higher quality than most of our peers, but we will own lower rated bonds where we have conviction. Right now, we own a larger allocation to investment grade bonds than we have in the past, just because the relative value between BBBs, to us, looks marginally more attractive in certain idiosyncratic situations, than the BBs do. So I think that exemplifies the strategy. We are willing to go where there is value, no matter where that value is found across the ratings spectrum.
The vast majority of what we own is going to be high yield bonds. We are allowed to tweak around the edges and we can own some investment grade, and we can own bank loans and other things. Again, we're nimble, we're flexible enough in both our thinking and our ability to trade where we can move the portfolio around where we think there's value. And our analysts have done an outstanding job of finding that value.
About Payden & Rygel
With over $150 billion under management, Payden & Rygel is one of the largest privately- owned global investment advisers focused on the active management of fixed income and equity portfolios. Payden & Rygel provides a full range of investment strategies and solutions to investors around the global including Central Banks, Pension Funds, Insurance Companies, Private Banks, and Foundations. Independent and privately- owned, Payden & Rygel is headquartered in Los Angeles and has offices in Boston, London, and Milan.
This material reflects the firm’s current opinion and is subject to change without notice. Sources for the material contained herein are deemed reliable but cannot be guaranteed. This material is for illustrative purposes only and does not constitute investment advice or an offer to sell or buy any security. Past performance is no guarantee of future results.
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