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First Eagle's Slein: High-Yield Fundamentals Solid

Sarah Bush

Sarah Bush: Hello. My name is Sarah Bush for Morningstar, and I'm here today with Sean Slein from First Eagle High Yield. Thank you for joining us today, Sean.

Sean Slein: Well, thank you.

Bush: So we've seen just very strong performance in the high-yield market in recent years. What's your outlook, and where do you see fundamentals in the market today?

Slein: Fundamentals in the market still very good. Over 60% of proceeds of primary issuance are still being used for refinancing purposes, which lowers the default risk of the market, as well as idiosyncratic default risk of various issuers. So, issuers are terming out near-term maturities, and essentially buying time to go into their capital structures. That's good. That's in contrast with what we saw in 2006 and 2007, when we saw more equity-friendly issuance, more dividend activity; more activity that was to the detriment of the high-yield investor.

Corporate managements in this environment remained chastened by their near-death experiences of 2008. So they’re more incentivized to manage their balance sheets and to ensure that they have a margin of safety regarding cash on the balance sheet, as well as availability of committed financing. So they are allocating capital a lot more efficiently and a lot more prudently than they had been in the past. And we feel that in this benign and stable credit environment that returns and risk are going to remain relatively manageable for the near term.

Bush: So, against that backdrop, where are you finding opportunities today?

Slein: We're finding opportunities in Europe, and we're certainly finding opportunities in the loan market, as well. We're concerned with interest-rate risk, and we're more than happy in this benign credit environment to take more credit risk versus interest-rate risk. And we feel that investing in the loan market, though we're giving up call protection and we're also giving up some basis points in terms of yield, that floating-rate nature helps insulate us from the possibility of an increase in interest rates.

As far as Europe goes, we've been participating more and more in European issuance over the last three years. The European market has tripled in the last four years. And as a result of Basel III [regulations] and banks having to manage their capital--banks historically had been intermediaries of credit in Europe--and as a result we're seeing the European capital markets begin to develop.

So, we're participating in that issuance primarily in Western and Northern European higher-quality larger companies. So, companies in the telecom industry, companies in the automotive industry, as well. The yield enhancement that we've been able to achieve versus a dollar-denominated--let's say, euro-denominated tranche versus dollar-denominated tranche--has narrowed somewhat over the last few years as risks of disintegration in Europe have receded. But we're still seeing some premium that we are able to pick up as a result.

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Bush: In terms of areas of concern, are there any parts of the market that you are avoiding or underweighting within your portfolio? What are some your concerns there?

Slein: We're concerned, again, with interest-rate risk. So, we're looking to underweight the BB credit tier, which tends to be more interest-rate-sensitive than the B credit tier and certainly the CCC credit tier. The higher up you go in credit quality, the more interest-rate sensitivity you get. So as a result, we're overweight the B credit tier, as well as we have the loan exposure. We're avoiding essentially lower coupon, longer-dated, higher-rated companies.

Bush: You’ve talked a lot about interest-rate risk. At what point do you think that would become a problem for high-yield investors? Should people be concerned about a 100-basis-point increase in rates? At what point does it become an issue?

Slein: We think high-yield could absorb anywhere from 100 to 150 basis points of a yield increase. Now, it would likely be uneven; the market wouldn't absorb it all at once. But given where spreads are right now at approximately 450 basis points, spreads will likely compress due to an interest-rate increase or a yield increase, rather than continued spread tightening. Given that spread cushion that we have right now, we think that 100 basis points is certainly achievable.

Bush: We were coming off a great period for high-yield investors, and I think we have something like 9% and 9.5% returns over the trailing five-year period. What would you tell investors today about what they should expect from high-yield going forward?

Slein: High yield, given the fact that two thirds of the market is currently callable, and therefore your upsides were truncated somewhat, we're still in an extremely benign credit environment, and fundamentals remain good. Companies are largely refinancing. We're not seeing leveraging transactions. So therefore, the investing environment is still solid. I would characterize it as an income-accrual type of environment, where investors should expect a coupon-type return over the coming years as long as we see credit conditions remain relatively sound.

Bush: Great. Thank you very much, Sean, for being with us today.

Slein: Well, thank you very much.

Bush: I'm Sarah Bush from Morningstar. Thank you.