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Hoff: Good Values Can Be Found in High-Yield Bonds

The high-yield market overall is trading at a discount, but the energy sector remains tricky, says Gold-rated Fidelity High Income manager Fred Hoff.

Sarah Bush: I'm Sarah Bush with Morningstar. Today I'm joined by Fred Hoff of [Gold-rated] Fidelity High Income. Thanks for joining me today, Fred.

Fred Hoff: Sarah, thanks for having me.

Bush: You run a high-yield fund with Fidelity, and it's clearly been a very difficult market for high yield, especially looking back to 2015. Maybe we can start by talking about what's been driving the losses in the high-yield market recently.

Hoff: The high-yield market has really felt the pain of the greater commodity cycle that's been taking place primarily because of the slowdown in China. There has been a lot of new capacity brought on in most underlying commodities, expecting China to grow at 8%-plus growth rates indefinitely. All that supply has become very problematic and prices started tumbling. That's really stressed a lot of companies' liquidity positions.

Bush: One of the other big stories from 2015 was the closure of Third Avenue Focused Credit and the concerns about how abruptly it was closed, and how that was handled. Alongside that, there has been concern about liquidity in the high-yield market. As you look at the current liquidity in the high-yield market, how are you thinking about it? Has it resulted in any changes in terms of how you manage the fund, and how does it impact the day-to-day experience for a high-yield investor?

Hoff: Day-to-day liquidity is probably a topic that's been overblown, in my opinion. We really have not had a problem trading at Fidelity. Our traders are very good at executing what we need to get done, and it really comes down to what you own in your portfolios. We feel like we have good portfolios with good holdings that other people would buy from us if we needed to sell some things. That's really the big difference between us and the Third Avenue fund; it's really what they owned. That portfolio was concentrated in distressed positions. The audience for that paper was very limited, and therefore they saw large price declines when they were trying to sell.

Bush: Has there been any change in terms of cash positions in the portfolio, given the current liquidity environment? How are you thinking about that in terms of portfolio construction?

Hoff: I have nudged up my new neutral cash position slightly in the fund, but we are only talking about basically a 1% increase in the fund, just to make sure that I have some added liquidity. We've seen more volatility in the marketplace. As opposed to liquidity issues, we've seen more volatility in prices. So I like to have a little extra cash there; that way I can buy on days when people are forced-sellers, and actually we can add some value that way.

Bush: As we look to 2016--you mentioned when we spoke earlier that the high-yield market is trading at 90 cents on the dollar and that presents some opportunities. How are you thinking about what opportunities are in the market today? Where are you finding value?

Hoff: We're finding good value in the high-yield market right now. When bonds are priced at a discount, if you can find companies that actually are going to improve their balance sheets over the next two to three years, you know that company's bond price is going to make its way back to par, as that company finds a way to refinance or pay it off. So it really comes down to the underlying free cash flows of the companies, and as long as we apply our individual analysis to the company's earnings and try to see what they are going to do with their balance sheets in the future, we know we're going to get back to par.

Bush: One of the hardest hit parts of the market, as you suggested, is the energy sector. Are there opportunities in the energy sector today, and are you adding to your positions in that area?

Hoff: The energy sector is a very tricky one right now. We've seen pretty much just one way in commodity prices for almost a year now. At some point we know that energy prices have to find some kind of bottom, as supply and demand gets balanced, but we haven't seen that yet. The supply is still swamping the demand for energy. My bias in general is not to own a lot of E&Ps. I find it very hard to invest in companies with large fixed-debt loads when they are not really assured of what their selling price is going to be.

Bush: Too much uncertainty in terms of what happens.

Hoff: Much too much uncertainty.

Bush: We're in January, which is the time of outlooks. How are you thinking about the outlook for the high-yield market this year? What should investors expect?

Hoff: The underlying economy in the U.S. appears to be pretty good. We're still seeing very strong job growth numbers. We have record auto sales. The housing market is continuing to improve. So, it feels to me that the underlying economy should be enough to help us find good investments in the marketplace, and because the market is priced at a discount, there are good opportunities in the market.

Bush: Fred, thanks very much for being with us today.

Hoff: Thanks for having me, Sarah.

Bush: For Morningstar, I'm Sarah Bush.

Sarah Bush does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.