Thomsen is a managing director and senior portfolio manager for the $3 billion high-yield trust at Putnam in Boston.
How will you respond to higher interest rates?
We will respond with two main strategies. We are overweight in single-B and double-C credits at the expense of double-B credits. We expect lower quality will outperform in the rising-rate environment. Also, we have taken advantage of strong capability in the bank loan market, as these floating rates should perform well in a rising-rate climate.
What sectors do you find most attractive?
We like the publishing sector. Operating performances should improve as state budgets are less stretched and advertising demand picks up. Specifically, we like Vertis and Von Hoffmann Corp. There is also a lot of opportunity in energy. We think consolidation will continue in that sector.
Where can one find relative value?
Broadly speaking, to out-yield one must own lower-quality or longer-term bonds. But the latter option is more sensitive to interest rate change, so we prefer to invest in lower-quality paper. We're looking to take advantage of the new issue calendar and add single-B coupons of 10% or greater that meet our strict research standards. Some new deals that we have participated in include UGS Corp. and Kabel Deutschland issues, which were attractive because both companies have strong cash-flow generating abilities.
What kind of structural protections do you look for?
There are several ways. In covenants, we make sure companies cannot dividend out an inappropriate amount of cash or take on an inappropriate amount of debt. We also look for protection from cash flows for companies and some sense of what cash flows will be.
What kind of process does Putnam go through before investing?
We have a prescribed process. For new issuance, we meet with management during a company's roadshow. Analysts look at a company's position in an industry, at its downside protection and study its cash flow profile. Then we look at the relative value of the bond in question versus competing investments. Last, we consider where it would fit into our overall portfolio; it all has to fit together like a jigsaw puzzle.
What do you expect fund flows to be like going forward?
It is hard to predict. Generally, as interest rates rise, it puts a damper on high-yield inflows as short-term credits and credit default swaps become more attractive, though high-yield still has a yield advantage. I would say it's hard to predict, but competition will increase.
How do you use CDS: as a hedge or to take positions?
We view those as another potential investment. There are times that derivatives are cheap relative to their bond equivalent and, at that point, we will view them as an attractive investment.
What's your view on default rates?
I'm bullish on default rates going forward. A large amount of the new issuance was refinancing; there have not been a lot of new names coming to the marketplace. Still, there are some leveraged companies that have only bought themselves time by refinancing, and will have to issue equity or have their operations improve. But the average issuer today is less leveraged than it was two years ago.