A New Fund for Yield-Hungry Investors
Interested in income? The average high-yield bond fund has returned 33% so far this year -- more than double the return of the major stock indexes. From March 9, when the stock market bottomed, through September 8, the average junk-bond fund gained 44%, compared with a 53% return for Standard & Poor's 500-stock index.
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The easy gains -- in both junk bonds and in stocks -- are likely behind us. But Third Avenue Management, the investment firm founded by Marty Whitman, an authority on distressed securities, has just launched a fund that could be the pick of the litter for yield-hungry investors. The fund's managers won't predict its yield, but I expect it'll be roughly 8%.
Third Avenue Value Focused Credit (symbol TFCVX) is run by two veterans. Manager Jeff Gary, 47, has more than 20 years of experience in the sector, most recently as head of high-yield investing for BlackRock. Tom Lapointe, 40, senior research analyst, has 15 years of experience.
Whitman, who worked as a bankruptcy specialist before starting Third Avenue Management in 1990, recently wrote a book entitled Distress Investing: Principles and Technique. In short, he knows how to select top-notch high-yield experts and how to work with them.
Whitman's firm, which today is majority-owned by Affiliated Managers Group, hasn't opened a new fund in eight years. All of Third Avenue's other four funds have been good performers.
There are plenty of other reasons to be excited about Focused Credit. First, it's a new fund. "We have a clean slate with no legacy positions," Gary says. The fund, which launched on September 1, had just $50 million in assets at the end of its first week. That means Gary and Lapointe can buy only what they really like (as opposed to holding on to stuff that they might not sell for tax reasons). The negative to a new fund: Expenses are high, at 1.40% annually.
Focused Credit is extremely flexible -- a huge plus in the complex and arcane world of high-yield investing. Gary will apportion assets among straight high-yield corporate bonds, leveraged loans, high-yielding convertible bonds and distressed securities. Distressed securities are obligations of companies in default-or on the brink of it.
He currently views leveraged loans -- loans made largely by banks to firms that already have a lot of debt -- as relative bargains. Leveraged loans rank ahead of bonds in a bankruptcy, and "recovery rates," the percentage of a borrower's assets that investors recover in the event of a default, are about 60%.
In junk bonds -- bonds issued by companies that have a substantial risk of default -- recovery rates average about 16%. Yet the average junk bond is trading at a rich 83 cents on the dollar. Bottom line: If you own a pure junk fund, you could get hurt.
That doesn't mean Gary will shun all junk bonds, which still offer enticing yields. The Merrill Lynch High Yield Constrained index yields 11.3% -- nearly eight percentage points more than the yield of ten-year Treasury bonds. At the height of the financial crisis, the spread between junk and Treasuries was 22 points.
Another advantage for the new Third Avenue fund: It will own only 50 to 60 securities, with no more than 5% in any one security. In contrast, the biggest 25 junk funds own about 350 issues, on average. "A lot of these funds are too big," Gary says. "By investing in a limited number of companies, we can do deep-dive research." Gary and Lapointe have four analysts assisting them, plus access to research from the firm's 21 other managers and analysts, including Whitman (Whitman runs Third Avenue Value, which invests mostly in stocks but also in distressed debt).
Focused Credit will invest almost exclusively in corporate debt and will avoid risky structured products and mortgage-related securities. Gary is leery of financial companies; balance sheets for many financials are hard to decipher.
In the current environment, plenty of otherwise-strong companies are beset by debt. "We look for companies with good pricing power, barriers to entry, a strong market share and good management teams," Gary says.
In keeping with Third Avenue's "safe and cheap" mantra, Gary and his team start by tearing apart a company's financials and determining what could go wrong. "We make sure that we understand and analyze the risks we take," Gary says.
He says banks will maintain tighter-than-normal lending standards for several years. Indebted consumers, meanwhile, won't spend nearly as much as they did previously. If he's right on both counts, plenty of hard-pressed companies will have nowhere else to turn for financing but the junk-bond market.
For many years, I thought that junk bonds and similar securities -- which typically offer stock-like returns in exchange for stock-like risks -- had a place in most investors' portfolios. I turned bearish on junk a couple of years ago. With the worst of the financial crisis behind us, I think it's time to wade back into this part of the market. I doubt that you'll find a better way to dip your toes in the water than the new Third Avenue fund.
Steven T. Goldberg (bio) is an investment adviser.