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| Dick Cryan |
Cryan is a high-yield portfolio manager at Evergreen in Boston. He is the lead manager of the $600 million Evergreen Select High-Yield Bond Fund, which is part of $5 billion in assets run by the firm. Can you describe the type of fund you run?
I manage the high yield institutional effort at Evergreen. Our flagship fund is the Evergreen Select High Yield Bond Fund. Our mandate is to run a conservative high yield portfolio and our goal is to capture the yield advantage that comes from a high yield investment for our clients while preserving principal as much as possible by avoiding credit downdrafts and defaults. Our clients, as you can imagine, are conservative institutions. We run the gamut from taxable insurance companies to family trusts to corporate pensions and corporate cash clients. The unifying theme for our clients is that they understand that there are markets in which a conservative approach may under perform, with 2003 being among them, but, that over time history demonstrates that a conservative high yield approach offers both great returns and less volatility than an aggressive approach. Generally, more volatility results in more returns but that hasn't held true for high yield in the past. In the institutional strategy we have about $1 billion and the Select High Yield Bond Fund is $600 million.
For our benchmark, we like the Merrill Lynch Master Index. We run about equal duration to the benchmark--however we run half the volatility. In most fixed-income disciplines you increase volatility by increasing duration, but that's not true in high yield. In high yield you increase volatility by lowering credit quality. The fact that we run a higher quality approach and have successfully avoided all defaults for more than three years is the way that we have reduced volatility of the disciplines.
What is your investment strategy?
We take a three-fold approach to our conservative high-yield strategy. Number one, we build conservative portfolios with broad diversification. For example on the institutional portfolio we don't buy triple-C bonds. We need a mid-single-B from our rating agencies when we buy a bond. We don't buy B3/B- . And we run a maximum 1% position. In so doing, we avoid the riskiest part of the high yield market so that if we are wrong and something goes bad it doesn't hurt the client.
The second part of our strategy is that we have a team of six analysts who do nothing all day but look at and talk to high yield companies. They know what goes into the portfolio and watch it closely once it's there. They are the reason we've had no defaults in over three years. They are terrific. The third and final part is that we are very quick on the sell trigger. We are not afraid to sell a bond that may be even 20 points below where we bought it to save our clients an additional 60 points if the investment goes bad. The key to managing a conservative portfolio is cutting losses quickly and ruthlessly.
What sectors do you like? Dislike?
We are positioned now with a cyclical emphasis to the portfolio. We've had that emphasis for over a year. We believed the economy was going to show good growth coming out of the recession. It took the economy awhile to start posting numbers but it's certainly going well now. Because we can't invest in the riskiest part of the market--the triple-Cs, which would react well to strong economic growth--we compensate by investing in the cyclical part of the market, such as chemicals, retail and hotel and leisure. We are underweight in utilities because many high yield utility companies were on the brink of bankruptcy a year ago. They have refinanced a lot of their debt and bought themselves time, but for many high-yield utility companies we think the business model is basically broken. We don't believe that most utilities that we've looked at are appropriate to our portfolio. We are underweight in telecom. We like telecom but with the problems they've been through, there are few companies that have the mid-single-B rating we require. We own what we can but the result is a big underweight.
What are some current themes in the high yield market and how are you responding to them?
I think the biggest surprise over the last six months and particularly over the last three months is the deterioration of the quality of new issues. In the first quarter almost a quarter of all new issuers were rated triple-C. That's a remarkably high number to see this early in the credit cycle. Typically, you wouldn't see that degree of speculation in the new issue calendar until near the end of the credit cycle. What are we doing about it? We are being extremely selective about what we buy. We aren't willing to jettison our conservative philosophy in order to chase short-term returns.
Which sell-side firms put out research that you find valuable, and why?
There's been a lot of consolidation on the sell side. I've always liked Merrill Lynch research. It's timely and thought-provoking. I particularly like the work that Chris Garman does. We also like J.P. Morgan Securities and I particularly like Peter Acciavatti, who is their strategist. Peter does excellent portfolio work comparing trends in professionally managed portfolios to gauge the sentiment of high yield investors and to gauge where opportunity lie. I think their analysts as well are very good. I'll tend to give a closer look to the analysts of a firm whose strategists I respect.
Are you seeing any interesting structures in the new issue calendar?
We are seeing a lot of dividends deals, where equity sponsors are levering companies in order to realize a return. That's very bad news. We scrutinize that kind of deal very carefully. Ultimately, why should the investing public be putting money into a situation that the insiders are taking money out of? Nobody likes dividend deals and that's where a lot of the triple-C issuance is coming from.
What kind of covenants do you want in new deals?
Covenants have been good. The high yield market learned the covenant lesson in the late '80s. The key covenant is the change-of-control put which protects bondholders from adverse effects of merger and acquisition activity. That to me is perhaps the single most important covenant in the package. Beyond that, covenants are important but it's more important to find management with reasonable business plans. That will protect investors far more than a covenant package. A smart lawyer can get around any covenant package.
What do you expect for coupon, what won't you accept?
I want to see a six handle on what I buy. I own a lot of paper that is below that but it's trading to a relatively short call or maturity. As you slide down the yield curve, the yields drop off very quickly. I try to take an intelligent approach toward yield judging bonds on a relative value basis rather than a hurdle return basis.
What is your outlook for the high-yield market for the year?
What I've been telling my clients is that the prospects for the high-yield market are good, the credit cycle is strong and getting better, and the comments by our analysts in high yield are very good as the companies are reporting first quarter numbers. It's looking very strong. However, the big returns for this cycle are behind us. I think investors should be thinking of capturing the coupon and protecting themselves against potentially higher Treasury rates rather than looking for 20% plus returns. That's just not going to happen. So it's good but tempered.