Aligned Incentives: Our Key to Navigating the Diverse High Yield Market
In our experience, family-owned private firms and small-to-medium sized public companies are most likely to borrow responsibly and prioritize bondholders ahead of other investors.
The high yield (HY) bond market is heterogeneous. The only real connection among HY securities is that they are rated below investment grade. Otherwise, the market is essentially a collection of individual bond issues. Each one has a unique covenant package, coupon, call schedule, maturity and rating, as well as idiosyncratic factors that influence how it will react to changes in the underlying business.
To help us sort through such a diverse universe, we rely not only on traditional due diligence methods, but also on a market segmentation approach that allows us to assess whether an issue is likely to be a good fit for our portfolio. Historically, we have found that the ownership structure of the issuer has been a reliable indicator of the alignment between the borrower’s incentives and our own.
We divide the HY market into the following four categories:
- Independent private companies
- Small-to-medium sized public companies
- Large public companies
- Financial sponsor-owned leveraged buyouts
In general, we prefer investing in bonds issued by the first two groups – family-owned private and small-to-medium sized public firms. We find they typically borrow responsibly and are committed to repaying their debts, which is of course our priority. We will consider investing in the other two segments, but only when we find bonds that meet our standards.
Our Primary Focus: Private and Small-to-Midsized Public Companies
Over the years we have had a lot of success investing in private companies, particularly family-owned firms, and small-to-medium sized public companies. We have found a few common traits among these two cohorts that we feel are positive differentiators.