This High-Yield Fund Breaks With the Pack to Find Its Edge
Security selection is key to Artisan High Income Fund's process.
Sumit Desai: Hi, I'm Sumit Desai with Morningstar. Joining me today is Bryan Krug, lead manager of the Artisan High Income Fund.
Bryan, thank you for joining me today.
Bryan Krug: Thank you. It's my pleasure.
Desai: So, Bryan, your approach is somewhat unique among funds in the high-yield bond category. Can you talk a little bit about your investment philosophy and how you think you are differentiated?
Krug: Sure. We've got a number of aspects about the way we approach the market that are very different than our peers. First of all, in terms of the way we evaluate, we tend to look at business quality. We have a slightly different definition. I think a lot of people look at business quality, and they focus on the credit ratings. We tend to look at the business ex its ratings, understand the quality of the business in terms of predictability of the cash flow stream, ability to delever, enterprise value, support, etc., which is very different. So, as a result, you tend to see we have a slightly different mix of overall businesses in our portfolio relative to the peers. A lot of our peers like more asset-heavy industries such as energy, commodities, and those are areas that we tend to view as more cyclical as opposed to defensive.
Additionally, we tend to go a little more cross-capital structure, which we think is very differentiated. We tend to look across the capital structure, and we are totally agnostic as to what part of the debt we invest in depending on our view on the business and the relative value of the securities that are available for us to purchase.
Desai: So that means you invest in high-yield bonds and also bank loans, is that correct?
Desai: So, to elaborate a little bit more on the concept of asset intensity, a lot of the types of names that we find in your portfolio tend to be asset-light companies. Can you talk a little bit about some of those examples?
Krug: Sure. So areas that we have--through a cycle I'd expect us to have material concentration to technology, specifically software. Insurance brokerage is another area that fits the criteria. Transaction processors is the third area that fits the criteria of strong predictable revenue, strong cash flow, strong enterprise value support, and meaningful ability to delever its balance sheet. So those are three areas that we find very attractive on a relative basis.
Desai: So since you launched the fund in 2014, performance has been really strong. It's actually been one of the best-performing funds in the high-yield bond category. Can you talk a little bit about what drove that performance, especially with somewhat of a pretty rocky market for credit investments?
Krug: Well, thank you. We've worked awfully hard. In terms of the drivers of alpha, I think our philosophy and process really showed itself in this environment. In this environment what you saw was on the high-credit-rating perceived companies such as energy, metals, and mining--which have very limited ability to control their own destiny due to the fact that commodities ultimately determine profitability--materially underperformed in this environment, and that is something that we tend to look at asset value as more of a stressed buyer, when there's stress in the market, and so it's something that we were light in, going into it. And then we have selectively added to it as there has been stress in the market. Additionally, there has been a number of companies that we've made individual investments that by themselves didn't move the needle but collectively they have really outperformed. So we have much more of an idiosyncratic portfolio as opposed to just a closet index-type portfolio.
Desai: And to that point, what's interesting about the performance of the fund historically is that the portfolio does tend to carry a lot of bonds and loans rated CCC. A lot of times the market kind of views that as very risky. And in fact, CCC bonds and loans performed really poorly in 2015. We've rallied so far in 2016. But when I look at your portfolio and it has a lot of CCCs in there, but I look at the performance, it doesn't kind of correspond with that too. Does that have something to do that overall philosophy? Can you explain what went on there?
Krug: Well, in terms of--credit ratings aren't necessarily always accurate. And if you look at a broad swath, you will find situations where CCCs have underperformed on a relative basis and outperformed if you look holistically. But since we have a more concentrated portfolio, it's more driven by our individual security selection. And 2015 is a prime example where most of the market was down, we were overweight CCC. CCC materially underperformed the market, and we actually outperformed most of our peers, which on the surface look to have more conservative portfolios. So I think that was a great example of our philosophy in terms of our companies for performing. Despite [the fact that] they may have a lower credit rating, they did a relatively better job. Likewise, you've seen our CCCs have underperformed in the latest beta rally that's because they quite frankly didn't have the same downside before. And so, it's a little counterintuitive, but that's just the nature of the philosophy and process and how it has played out.
Desai: Great. Bryan, thank you very much for joining me. I appreciate it.
Krug: Great. Thank you.
Sumit Desai, CFA does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.