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By Michelle Ward, CFA | 03-19-2013 12:00 PM

Why High-Yield Spreads Should Grind Tighter

With a strong fundamental tailwind, high-yield spreads actually should be tighter than historical averages, argues Western Asset's Michael Buchanan.

Michelle Canavan: Hi. I'm Michelle Canavan, mutual fund analyst with Morningstar.

I am here today with Michael Buchanan, the head of U.S. credit at Western Asset and lead manager on Western Asset High Yield.

Thanks for joining us today, Michael.

Michael Buchanan: Thanks for having me here, Michelle.

Canavan: The high-yield market posted very strong gains in 2012, and your fund was among the top performing. Can you discuss how the fund was positioned to produce such strong results?

Buchanan: We were, obviously, very happy with the results for 2012, and we felt like going into the year, we were really poised to have a good year, because if you look at 2011, it was really the large-cap, very liquid, actively-followed names that outperformed, and pretty much everything else got left behind. And we really felt like there was some great value in the market, and the disparity between the on-the-run, very liquid names as opposed to everything else, that gap just became too wide.

So, just based on our disciplined, fundamental, bottom-up research, we were really excited going into the year, and that's certainly what happened. If you look at our attribution, and where all the alpha was coming from, most of it was coming from just bottom-up issuer selection. So, there were quite a few names that contributed.

Beyond that, we did have a slight overweight to CCCs, which at the margin helped, as well as some pretty good tactical bets within certain industries. So, for instance, financials; we timed that one pretty well. We ended up going from an underweight at the beginning of 2012 to an overweight within, really, the first month of the year, and that really produced outsized returns as well.

Canavan: And, going forward, what's your near-term and long-term outlook for the high-yield market? And maybe tie that into how the positioning changed as a result.

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