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| Barrie Whitman |
Whitman is a senior portfolio manager in London at Threadneedle Investments, the international investment arm of American Express, where he is responsible for its €1.5 billion in high-yield bonds. He has been at Threadneedle for five years and previously was at Standard Bank.
Where do you see opportunity in high yield?
With generic spreads so tight across the board, there's little room for capital appreciation and we're focusing on names offering an attractive coupon. It's a question of rigorous selection on a name-by-name basis, as we're not expecting outperformance from an industry sector or rating class, like triple-Cs in 2004. That said, some sectors may underperform in 2005 and could include autos and retail in our opinion.
How would the potential General Motors downgrade affect high-yield portfolios?
The real question is how the credit markets as a whole would react to such a downgrade, if it were to happen. I think it would provide a wake-up call to all credit investors regarding how to price risky assets, and would make people reevaluate whether they are getting things right. It could have a serious effect on risk appetite in the credit markets, possibly causing spreads to widen as investors reconsider the appropriate relationship between risk and reward. There could be contagion, absolutely--but to what extent would depend on the psychology of the market.
As to the specific impact a massive amount of GM bonds entering the junk universe would have on European high-yield investors, it may not have the massive impact some are suggesting. Most high-yield investors are benchmarked against a constrained index, having learned from the experience of fallen angels in 2001 and 2002. There would be an automatic cap of 3% on GM in most European benchmarks, and in any event investors could choose not to invest in GM even if it did enter their benchmark.
What do you make of the increasing leverage in new issues and proliferation of pay-in-kind notes?
Highly leveraged capital structures are not a problem in and of themselves--the high-yield market was born of leveraging good quality cash flows. It's a question of what is being leveraged and what return is being offered for the additional risk. For example, if a company has a strong and reliable cash flow stream, has exceeded expectations for deleveraging and has a positive event on the horizon, then a certain amount of releveraging is perfectly reasonable.
We see such companies as fine investments and there's nothing wrong with leveraging up again. Warner Music, Cognis and Kabel Deutschland are all examples of companies where it makes sense to invest at a subordinate level in PIK form, given that the incremental yield compensates for the incremental risk.
What are the prospects for jumbo deals in the European high-yield market?
I believe we're at a point in the development of the high-yield market in Europe where the investor base can accommodate deals of several billion euro-equivalent, and could swallow a large investment-grade company rather than just a division thereof. A leveraged buyout to the tune of €6-7 billion, financed 40% through high-yield, 40% through bank debt and 20% through equity could get done in Europe.
How is your allocation shifting between investment grade and high yield?
We've been overweight high yield for the past two years, and are now shifting from a maximum overweight position toward a neutral position. While the credit environment is benign and stable, there is little room for it to improve, and the market is fully pricing in the positive fundamentals.
Furthermore, technical factors remain robust and it's hard to see them changing in the near future. Demand is strong and growing from all quarters--both retail and institutional investors, as well as the structured product bid.
On the supply side there are definite constraints. About 20% of the high-yield market will be disappearing in the coming years as fallen angels return to investment grade and companies wanting to refinance their high-yield debt have already done so; that leaves refinancing of bank debt and LBOs as the only real drivers of supply and LBOs tend to have long lead times and can't be brought to market quickly to soak up excess demand.