Niklas Nordenfelt, CFA, and senior portfolio manager with the U.S. High-Yield Team talks about how their bottom-up approach helps them navigate the high-yield space.
Laurie King: I’m Laurie King, and you are listening to On the Trading Desk®. We continue this short series of fixed-income perspectives from portfolio managers with Wells Fargo Asset Management who addressed an audience in November of this year to discuss their strategies and how they’re navigating current events.
This week we hear from Niklas Nordenfelt, CFA, senior portfolio manager, managing director, and co-head of the U.S. High-Yield Team—a team known in the industry for its rigorous, bottom-up approach to security selection. They also tap the vast resources of Wells Capital Management to support the team’s intensive research philosophy.
Niklas and his team watched as the tax reform story took shape. They focused on what’s most relevant to them—the potential loss of interest deductibility. Considering which companies could be most effective, it might benefit their style.
Niklas Nordenfelt: Paying less taxes is a great thing if you pay taxes. So, the issue with the high-yield companies is most of our companies don’t pay meaningful taxes. So reduction in the corporate tax rate is not going to have much, if any, meaningful benefit to the high-yield market.
What’s more relevant to us is the potential loss of interest deductibility. You find yourself in high yield by borrowing a lot of money and being highly indebted and paying significant interest expense. So, having the ability to write that off is significantly positive. We think the probability of interest deductibility going away is relatively low. And to the extent that it does, it will be likely phased in over time or some sort of cap or combination of the both. So, our view is that near term, it will have very little impact on the high-yield market. To the extent that it does occur in a full-blown way, it’s most likely to occur in the most indebted companies, which are generally triple-C rated companies, and on the margin, will probably benefit our styles, since we tend to be underweighted the most indebted companies in the high-yield market.
Laurie: U.S. high yield, or high yield generally, has enjoyed an incredible run for a number of years since the financial crisis—albeit with a few speed bumps on the way, such as with oil and energy prices declining from more than a hundred bucks a barrel to less than half that a couple of years ago. Some might say the market now has gotten a bit rich. Niklas shared his team’s view, assessing the relative risk and reward characteristics of each individual credit.
Niklas: That speed bump’s a great thing, and I’ll tell you why. So, we think high yield is relatively attractive, emphasis on relative. We’ve gone through many years now where central banks globally are engaged in quantitative easing, and this really distorted fixed-income markets where yields are artificially low wherever you go in the world. Within that context, high yield’s yield is actually pretty attractive—spreads are tight, but they should be, because conditions have rarely been better in high yield. Companies are doing well. We recently had a default cycle, which is what I mean, and going through that default cycle, which was very concentrated on the commodities sector, it put a halt to really aggressive issuance.
Because normally this type, this part of the credit cycle, you see a really aggressive issuance leveraging deals and really a pollution of the high-yield asset class to more risky credits. There are aggressive deals being financed but it’s really being financed in the bank loan markets. What we are seeing is a sort of dichotomy where the high yield market is fairly valued in a world where it is pretty hard to argue that anything fixed income is fairly valued. But a less risky asset class, bank loans, which is a little more risky from a structural basis.
Laurie: If you’d like to learn more about the U.S. High Yield Team, visit wellsfargoassetmanagement.com. I’ll thank Niklas Nordenfelt for sharing his team’s insights. And I’ll thank you, our audience, for listening. Until next time, I’m Laurie King; take care.