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One of Our Favorite High-Yield Funds

Gold-rated T. Rowe Price High Yield has married rigorous bottom-up research and top-down macro views to generate great performance with modest volatility.

Cara Esser, 04/29/2017

The following is our latest Fund Analyst Report for T. Rowe Price High Yield Fund PRHYX

T. Rowe Price High Yield has implemented the same value-driven process since manager Mark Vaselkiv took over in 1996. Rigorous bottoms-up credit selection has been successfully married with top-down macro analysis from T. Rowe Price's veteran investment committee members, all at a reasonable price. T. Rowe Price and Vaselkiv have a history of putting shareholders first, including by closing this fund to new investors in April 2012 (the second time during Vaselkiv's tenure). The fund retains its Morningstar Analyst Rating of Gold.

Post-2008, Vaselkiv and his team have taken a more opportunistic approach here, crossing the credit spectrum, significantly over- and underweighting sectors, and adding out-of-benchmark securities as valuations warrant. Since 2009, the team has taken its non-U.S. stake as high as one third of the portfolio, including, at times, a sizable allocation to emerging-markets corporate bonds. Bank loans have figured prominently here in recent years, reaching 14% of the portfolio as of December 2016, up from about 8% a year earlier. Vaselkiv has believed we are in the last stages of a credit cycle for some time and prefers higher-quality credits, including first-lien bank loans. He's also using these securities as a hedge against rising interest rates.

The team backing Vaselkiv is an experienced one and has proven its worth over time. Credit selection typically accounts for most of the fund's strong relative returns--this includes what they don't own. For example, the fund had a years' long underweight position to energy and commodity names heading into the 2014 decline in oil prices, which helped rein in the fund's losses amid the sell-off. Vaselkiv has since waded back into energy and commodity sectors, favoring higher-quality names including so-called "fallen angels" (formerly investment-grade-rated bonds), raising the portfolio's overall quality. This team isn't perfect, however, and a significant allocation to troubled pharmaceutical firm Valeant has weighed on recent returns. In all though, Vaselkiv has had more hits than misses and this fund remains a top choice in the Morningstar Category.

Process Pillar: Positive | Cara Esser, CFA 04/25/2017 
Longtime manager Mark Vaselkiv and his team are on the hunt for undiscovered firms or those primed for a turnaround. In that vein, many of this fund's holdings have split ratings because analysts are looking for firms on the verge of a turnaround, selling at compelling valuations. Top-down views are also at play here though security selection is this team's bread and butter. Over the long term, the team has married rigorous bottom-up research and top-down macro views to generate great performance with modest volatility, earning the fund a Positive Process Pillar rating.

Non-U.S. high-yield bonds and out-of-benchmark holdings, including equities and bank loans, figure prominently here. Vaselkiv began adding to non-U.S. bonds in 2009 after the firm hired a London-based high-yield portfolio manager. At times, that allocation has reached one third of the portfolio. Equities tend to account for a few percentage points while bank loans could make up as much as 15% of the fund.

Vaselkiv doesn't shy away from credit risk if he believes there's a good risk/reward proposition (he's held a significant portion of CCCs in the past), but he will take a more conservative stance when warranted. For example, he trimmed the lowest quality holdings in recent years, adding to fallen angels, subsequently raising the portfolio's overall quality.

Over Mark Vaselkiv's long tenure, he's shown a willingness to move across the credit spectrum, into and out of sectors, around the globe, and hold out-of-benchmark sectors as valuations warrant. The fund took a more aggressive stance post-2008 as high-yield bonds sold off and valuations became attractive. The fund remained aggressive (based on credit quality) for several years, though began to reduce its energy names as early as 2012 as analysts identified what they considered a long-term supply/demand imbalance. The fund was about 4 percentage points underweight energy versus the Credit Suisse High Yield Index in mid-2014 when oil prices began their precipitous decline. Vaselkiv remained underweight through mid-2016, when he picked up a significant number of fallen angels. He continued to add through 2016, bringing the allocation in line with the index by year-end.

To reduce the fund's sensitivity to rising rates and to improve its overall credit quality, Vaselkiv has been adding to bank loans. That allocation was 14% at the end of 2016, nearly double a year earlier. Non-U.S. high-yield bonds have dropped since last year (to about 20% from around 30%), though Vaselkiv has added to emerging-markets corporate names (about 5%) with the help of T. Rowe's emerging markets team. The core of this bucket remains in European names, mostly in the telecom sector.

Performance Pillar: Positive | Cara Esser, CFA 04/25/2017
The team's strengths lie in its ability to pick winning credits. It has been more than successful on this front, earning the fund a Positive Performance Pillar rating. The fund has done well against peers, landing in the top quartile of the high-yield Morningstar Category over the trailing 10 years through March 2017. Over his tenure, Mark Vaselkiv and his team have made some prescient calls, including avoiding some of the hardest-hit telecom names before the dot-com crash, allowing the fund to post a small gain during that sell-off; and more recently, avoiding the worst of the energy slide from mid-2014 through early 2016. During the latest downdraft, Vaselkiv didn't take his foot entirely off the gas, and added aggressively to fallen angels in the energy and commodities sectors in early 2016. The fund landed in the top third of peers during 2014, the top half during 2015, and near the top third in 2016.

This team isn't perfect, however, and a sizable stake in troubled pharmaceutical firm Valeant has weighed on recent returns. Valeant was the fund's second-largest position in early 2016, growing from about 75 basis points in 2014 to 1.6% as of March 2016. Vaselkiv remains confident that the firm will pay its debt, but he concedes the holding will be volatile for some time. That stake, which has fallen below 1% recently, was the worst-contributing name in the portfolio in 2016, costing it 7 basis points of return. 

People Pillar: Positive | Cara Esser, CFA 04/25/2017
Mark Vaselkiv took over this fund in 1996 after eight years as a high-yield credit analyst with T. Rowe Price. As the firm's chief high-yield expert, he serves on the allocation committee that sets the weighting of asset classes and sectors for T. Rowe Price's allocation and target-date funds. He's also a member of T. Rowe Price's fixed-income steering committee, a group of senior managers who oversee management and performance for the company's fixed-income fund lineup. In March 2017, Vaselkiv was named as one of six co-CIOs for the firm following the retirement of longtime CIO Brian Rogers. He is the only fixed-income manager among that group.

Vaselkiv is assisted by two portfolio managers, 15 analysts (including three European high-yield analysts based in the firm's London office), five high-yield traders (one based in London), and two quantitative analysts. The traders manage the buying and selling for this and T. Rowe's other high-yield portfolios, and the quant analysts assist in tracking portfolio risk and support the traders around relative value judgments. Vaselkiv and his team make most of their buy/sell decisions as a group, with the European analysts participating via video conference. They also regularly call on the company's large stable of equity analysts for additional insight into specific companies. The deep bench and long-tenured team earn the fund a Positive People Pillar rating.

Parent Pillar: Positive | 04/06/2017
T. Rowe Price is evolving but retains the strong research-focused culture that's driven its long-term success. Despite the retirements of some long-tenured portfolio managers, the former CEO, and outgoing CIO Brian Rogers, the firm's careful focus on succession planning and long transition periods have eased the process. Even with a changing of the guard, there's no lack of talent. Successful former portfolio manager Rob Sharps is now co-head of global equities and oversees five CIOs who are among the firm's top managers. The analyst team is on solid footing, and the firm has continued hiring despite the pressures facing active managers. CEO Bill Stromberg, who joined T. Rowe in 1987 as an analyst, maintains an investment focus while recognizing that the business must evolve to flourish in an industry that's gravitated toward passive investing. The firm is bolstering its technology resources and is expanding its distribution overseas, achievable goals given its pristine balance sheet. In 2017, the firm opportunistically acquired the Henderson High Yield Opportunities team, led by a former T. Rowe employee, as it addresses demand for capacity-constrained strategies that are also part of its popular target-date lineup and potentially new multiasset products down the line (several T. Rowe strategies are closed). T. Rowe is sensibly adapting, and its fundholder-first mentality and ability to attract and retain investment talent support its Positive Parent rating.

Price Pillar: Positive | Cara Esser, CFA 04/25/2017
This fund's largest share class charges a 0.75% expense ratio, which ranks below average for similarly distributed peers; the remaining assets reside in a share class that charges fees that rank in the lowest quintile among similarly distributed peers. The fund earns a Positive Price Pillar rating.

To minimize short-term trading, a particular hazard in this relatively illiquid corner of the market, those who redeem their shares within 90 days of purchase face an additional 2% fee.

 

Cara Esser is a closed-end fund analyst at Morningstar.

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