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Atteberry: Red Flags Still Flying for High Yield

Jason Stipp

Jason Stipp: I'm Jason Stipp with Morningstar. We're here in California visiting with FPA fund managers, and I'm here today speaking with Tom Atteberry. He's a portfolio manager on the FPA New Income Fund. Thanks so much for joining me today, Tom.

Thomas Atteberry: Appreciate you guys coming in.

Stipp: So the first question for you: your fund has been guided by a principle one of its principles of "don't lose money." I think, in 2008, not a lot of people would have argued with having that kind of philosophy for managing a portfolio. In 2009, though, it's a different story when the market is rallying hard, when you have a "don't lose money" sort of philosophy. So I'm wondering if you can put the fund's performance in 2009, which was behind the category average, if you could put that into some perspective, as far as your strategy goes and how you think about a year like 2009, as a portfolio manager with your philosophy.

Atteberry: OK, the first thing to keep in mind on our philosophy, we're looking at periods of time for investment, three to five years. That being said, you have to deal with situations such as 2009. So, specifically looking in we saw coming from 2009, you divide the portfolio in two. That that might take on a credit risk, and that that's going to take on an interest rate risk.

We found ourselves, at the end of 2008, in extremely low levels for Treasury yields. So you've got a lot of potential risk for duration, and for price risk, there. And the reason you do is it's a massive flight to quality. You're looking at a 10 year, that's at almost 2%. So we realized we need to protect against that sort of release of: "Oh my gosh, the world isn't coming to an end!" and that flight to quality trade tends to come off.

What you did see, during 2009, was in general interest rates rose at the medium and longer end. Obviously, at the very short end, Fed policy pegs it to zero. Combine that with: Yes, you look at high yield, or credit exposure, it looks inexpensive. But you're also facing something that tells you: All right, I have a financing system that's broken that needs to get fixed and the only way, so far, it's being fixed is, we're going to throw a ton of money at it.

So as we entered, we realized that our high quality side was not going to generate much of a return for us, and was going to be under pressure from some form of rates rising, whether it's a lot, whether it's moderate, whether it's de minimis... We weren't sure, but we realized we were at an unsustainable level there.

The high yield side of the equation... We had a vigorous internal debate: should we purchase or not, this looks cheap from a spread and from yield basis? At the end of the day, our decision was: no. And it was really predicated on two things. From a fundamental standpoint, we went: "No, we're not going to see an economy that's going to pick up by a discernible amount." Significant damage has been done; the willingness, and the ability, of a bank to lend is very constrained; the willingness, and ability, of a consumer to borrow is vastly constrained. So we didn't see that fundamental piece.

And then, from a technical aspect, we realized that: OK, we could see rates rising, which means the high quality falls in value. It's not earning us very much. It doesn't protect us if we make an error, a fundamental analysis error, in high yield.

Now, in retrospect, what we missed was a massive amount of money that was willing to flow into high yield, to bail these companies out from the standpoint of extend maturities. The leverage is still there. These companies are still too highly levered to exist unless growth is tremendous, but they just pushed the maturities out for a few years. So we still continue to see high yield as a problem, just the problem, the can got kicked down the road a couple of years.

Stipp: So would you say then, for high yield investors today... would you avoid that area because of that risk that's just been pushed out? And that this debt is going to be coming due, I think, 2012, I've read, through 2014, as potentially another problem area. Do you still see that as a major risk factor?

Atteberry: Yes, in the high yield spectrum we see that as a major risk factor. A company that's five, six, seven times levered you know, debt-to-EBITDA is really in an unsustainable state. It can't last for a long period of time that way. It needs to either raise equity, or it needs to grow into its balance sheet. And we don't see either of those as high probability outcomes. So you've just sort of delayed that event of: how do I restructure this company to have more equity? Not eliminated it.