High Yield Done Differently

A tried-and-trusted approach 

Kempen’s European High Yield strategy may have only been launched three years ago, but the team running it has a much longer history. They have been working together since 2008, over which time they’ve built up an excellent track record in their Investment Grade credit portfolios.

And they follow exactly the same tried-and-trusted process in our High Yield strategy.

Our investment philosophy is “alpha by control”. This involves combining a top-down view with bottom-up credit analysis within a strict risk-control framework because credit is an asymmetric class – you can make small gains but suffer big losses if you invest in the wrong firm. Disciplined implementation of our process to produce well-diversified portfolios enables us to limit downside risk and generate alpha in a controlled manner.


Within High Yield, we focus on high-quality firms – the BB section of the universe – and have a highly active approach, combining a top-down view with bottom-up analysis. We estimate through a proven scoring framework where the market is going over the months ahead and set risk limits based on this view. Every team member is responsible for coming up with ideas about how to fill the risk budget and put our clients’ money to work. 

What really distinguishes our team is that there is no clear split between analysts and portfolio managers. All team members are responsible for generating trade ideas and everyone is accountable for the positions in the portfolio. That means there’s a high level of involvement among all team members – everyone has skin in the game. And their expertise in Investment Grade is an extra benefit: spotting trends early on in the Investment Grade market can help them predict what’s going to happen in High Yield, and vice versa.
 

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Integrating ESG throughout our European High Yield process 

Considering ESG within High Yield credit portfolios doesn’t come as standard. But at Kempen we integrate ESG criteria throughout our investment process for European High Yield credit, just like we do for every asset class that we manage. We believe this makes us stand out from the crowd. 

We integrate ESG in three ways.

First, we entirely exclude companies in breach of the UN Global Compact or that are involved in certain practices – mainly tobacco and controversial weapons – from the investment universes of all our company’s managed portfolios. 

Second, our Credit team forms an opinion on the ESG credentials of every firm it is considering investing in. It integrates this into its sector rankings in just the same way as it does for other important fundamental characteristics, such as its financials or the strength of its management team. If we believe a firm has a weak ESG profile, we adjust its position in our ranking and require it to provide a higher spread if we invest, and vice versa. Alternatively, we may even refrain from investing in it. An example of the latter is Chemours.

Finally, we engage with companies that we believe we can encourage to make a positive change to their ESG behaviour. We might team up with other asset managers to maximise our combined influence, or act on behalf of our firm with support of a dedicated ESG team. We continually engage with several companies. Our engagements can have a significant impact: for example, in the High Yield universe we urged chemicals firm Huntsman to improve its ESG reporting and embrace the UN Global Compact, which is exactly what it did.

Another consideration is that the BB segment of the universe that we focus on has a better ESG profile than the broad European High Yield market, which means our portfolio has a natural bias towards the more sustainable companies within the asset class when looking at ESG ratings. 

 

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The Power of BB's

Within the Kempen Euro High Yield strategy, we focus on the BB segment of the European high yield universe – the highest-quality and fastest-growing segment of the market. We also believe it’s the most attractive part, for three main reasons.

First, it makes up the largest share of the European high yield universe, which means it provides lots of issues and therefore opportunities to invest in.

Second, and most importantly, BB issues offer the best risk-adjusted potential within the high yield universe for long-term investors. That’s because BB companies are better able to withstand economic shocks – such as the coronavirus crisis we’re currently in the midst of – than lower-rated firms, and are therefore less likely to default on their obligations: the average annual default rate of BB firms has been just 0.5%, compared with 2.0% for B rated companies and 7.6% for CCC firms. BB companies typically have a strong business profile and are often global leaders in niche markets: a good example of such a firm is Smurfit Kappa, a world leader in packaging products. 

 

Third, BB bonds provide significant alpha opportunities where investors can exploit the cross-over dynamics. Bonds downgraded from investment-grade to high-yield status (‘fallen angels’) typically underperform prior to the downgrade but outperform subsequently as other kinds of investor come on board. And bonds upgraded to investment-grade (‘rising stars’) generally outperform already whilst still being rated BB.

We complement our exposure to BB bonds with an allocation to subordinated bonds issued by investment-grade firms. As they sit between equities and senior bonds in the capital structure, they provide high-yield-like spreads, and even a small allocation to these instruments can lead to big improvements in the Sharpe ratios of our high-yield portfolios.

Especially in today’s highly uncertain economic environment, focus on quality is essential.

 


 

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 Euro high yield is a standalone asset class

Investors have long tended to take a regional approach to investment-grade credit, recognising that the US and European investment-grade credit markets behave quite differently. But they have generally allocated to high yield in a global strategy. We believe it’s time for that to change.


That’s because the euro high yield market has grown quickly over the past decade and is now big enough to be seen as a standalone asset class. Since 2007, the market has quadrupled in size to over EUR 300 billion 
1, mainly due to an increasing number of firms issuing bonds to raise funding. That’s more than wide enough to build well-diversified portfolios that provide exposure to companies from across Europe operating in the full range of sectors.

What’s more, the market’s growth only looks set to continue as European firms seek to reduce their dependence on bank funding. Meanwhile, investors are proving eager to invest in European high-yield debt in their search for yield in a low-rate environment.

At Kempen we believe that euro and US high yield should be seen as distinct asset classes. The two markets behave quite differently, and anyone sitting in the US running a global high-yield strategy is likely to have a difficult time grasping the supply and demand dynamics affecting high-yield returns in Europe. What’s more, global strategies tend to have a disproportionate weight in the US, neglecting the opportunities that Europe has to offer.

All this is why we provide investors with discrete access to the European high-yield market. Run according to the same tried-and-tested approach as our investment-grade portfolios, our European high-yield strategy exploits all the inefficiencies prevalent in the market in a way that would be difficult for a global approach to replicate.

And finally, in these turbulent times dominated by news about the coronavirus, the European high-yield universe has held up relatively well so far because of its limited exposure to oil companies. We believe that at the current spreads the Euro strategy is attractive.

  1. ICE Bond indices, as per 31 December 2019

 

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Disclaimer 

Kempen Capital Management N.V. (KCM) is licensed as a manager of various UCITS and AIFs and authorised to provide investment services and as such is subject to supervision by the Netherlands Authority for the Financial Markets.

This document is for information purposes only and provides insufficient information for an investment decision. This document does not contain investment advice, no investment recommendation, no research, or an invitation to buy or sell any financial instruments, and should not be interpreted as such. The opinions expressed in this document are our opinions and views as of such date only. These may be subject to change at any given time, without prior notice.