High conviction, flexibility and finding value in high yield

Darius McDermott (DM): I’m Darius McDermott from FundCalibre, and today I’m delighted to be joined by Tom Hanson, co-manager of the Aegon High Yield Bond fund. We’re gonna talk about all things super exciting and high yield. Tom, good morning.

Tom Hanson (TH): Morning.

DM: So let’s just do a quick recap of the fund. It’s high conviction, flexible approach to high yield investing. What in practice does that mean to you and to people who potentially might buy the fund?

TH: Yeah, I think we wanna make the most of our analyst platform. We’ve got a lot of good idea generation. We are firm believers that performance is generated from the bottom up in high yield as most people would be. But we think that we can create a concentrated portfolio of 100 to 150 line items that really juices the most of that, if you want. I know some of my peers will perhaps take a slightly more diversified approach and run, 300, 500, even more, up to 1,000 line items. I think the average is 300.

But for us, picking your best ideas, this is very much a best of the best global high yield ideas fund. Representing ideas in conviction size and then marrying that with a top-down overlay is the key way that this, this fund generates performance. But you know, need to remember as well alongside that, we are very index agnostic and that is a hugely important part of what this fund does and how this fund unlocks value because we’re firm believers that the benchmark is a suboptimal construct — should we put it like that? You know, the biggest weight in a benchmark, that governs our world are those that have the most debt outstanding. Don’t use that as your blueprint to, you know, create a portfolio. So we don’t. We start with a blank sheet of paper and we build it from the bottom up from there.

DM: And 100 to 150 in an equity fund would be very diversified. But in bond world, that actually isn’t the case, is it?

TH: No, I think, look, it’s an asymmetric payoff, right? In equity world, you’re paying for, I guess, unlimited upside. In our world, you’ve got a strictly limited upside, you’ve got your coupon, you maybe you’ve got a bit of a takeout above par, but in reality, you know, it’s about protecting the downside. So we think that’s the right number.

At times we’re gonna towards the bottom end of that range, perhaps when we’re a little bit more bullish. At times when, as we are now, we’re a bit more cautious. We’re perhaps gonna be towards the top end of that range. But as an effective operating environment, that’s kinda how we do it.

DM: Just finally then on the flexibility and the index agnostic, I know that you’ve only got a small percentage US high yield to the 15-ish percent. What sort of position is that in the benchmark, just so we can measure the quantum of your agnostic behaviour?

TH: Of course, so the benchmark world, and we wanna beat our benchmark, by the way, right? We just don’t agree with how it’s constructed. Like a benchmark global high yield world is probably best thought of a 60% US high yield. So, 20% Europe…

DM: To my mind, we’re actually highlighting that – Yeah. You are flexible and agnostic. That’s not that you wouldn’t go back to the US when the opportunity arises if, if and when it does.

TH: 100%. And, you know, if I could show you a chart that shows our historical allocations, there’ll be times when we’ve been heavily weighted towards the US and far less heavily towards Europe or perhaps zero times emerging market. The key thing when you’re considering our fund is flexibility to your point, we’re gonna go where the opportunity set is. We’re gonna go where we think the best risk adjusted returns are gonna be available to us. And at this point in time, that is manifesting not the US high yield market. It is European high yield and in particular subsets of European high yield, sterling, we can talk about. And it’s hard currency emerging market, just not the US, but that won’t always be the case.

DM: So let’s talk about the high yield market then this year. It’s been a challenging start to the year. We obviously have had the conflict in Iran and Middle East and that’s certainly had a lot of impact on volatility and oil and energy. And there’s the whole AI disruption thing that’s going on. Mostly been an equity story, but started to enter the bond market as they now have to borrow to fund this CapEx and the high, and entering the high yield as well. So tell us a little bit about sort of what you’ve managed to do to stay ahead this year.

TH: Yeah, it’s a difficult year this year. I mean, there’s rarely an easy year in high yield if truth be known. It’s part of the joy in working in the high yield market. A lot of volatility, but a lot of opportunity. But yeah, I mean, the worries have been stacking up.

So clearly the geopolitical situation in the Middle East, which obviously at this point in time is showing signs of causing pressure once again is one thing. The AI disruption, I mean, that’s gonna be a concern for everybody no matter what market. We can talk a little bit more about that. Also, private credit, what’s going on there, potential transmission mechanisms. So you kinda got a few different pockets of trouble, potential trouble, if you like. The key thing is spreads are still pretty tight so your margin for error is pretty thin in our market.

But from our perspective, it’s really been about focusing on the best parts of high yield that we can and avoiding perhaps some of the pitfalls. So we’ve been quite clean from a sectoral perspective this year. We haven’t owned much chemicals, which has been, if any, actually at points, which has been a troubled sector. , We’ve been almost maximum weight our energy exposure, about 20%, something like that.

DM: Which has been a nice sort of barbell for that sort of oil price rise and conflict. [TH: Totally.] The chemical industry suffered to get…

HT: Presumably the margin compression, cost pressure. Exactly. Energy is obviously benefited for certain reasons. So we’ve done well there. Some of our bigger top down calls have worked such as Europe versus US. I think currency are just, 100% currency hedge basis. Europe is streets ahead now. Sterling has continued to do very well. And actually the bright spot has been emerging market high yield, which is, delivered by far the most of the subsets of global high yield in total return to it.

DM: So I know we’re gonna talk a little bit about emerging markets in a bit, but I’m interested in the sterling bit because obviously we live in the UK with sterling, we earn in sterling, we spend in sterling. Yet you say it’s almost not an emerging market list, let’s not quite go there, but…

TH: No, I definitely didn’t say that.

DM: An unloved market. [HT: Yeah] Where you’re able to get a yield premium.

TH: 100%. And as a rule, that’s kind of the sort of thing that, that me and Mark would like. So, you know, we run the fund to try and capitalise an opportunity. If we can find a more off the run opportunity, so much the better. Sterling high yield is that and really, you know, you can go all the way back to the original Brexit vote in 2016. Before that, on a pound for pound basis, sterling used to be at least perceived to be a higher quality market than its corresponding, Euro equivalent. But ever since then, it’s traded with the spread premium. We’ve obviously had difficult political situation, continue to have political, fluctuations and volatility. But what it means is there is perhaps less of a dedicated buyer base for sterling high yield.

And what that has to mean is a lot of sterling bonds trade cheap. Now, it’s not as simple as owning everything in the sterling high yield market. Of course. There are, you know, there are winners and there are losers, but, you know, there is a lot of opportunity there and we continue to benefit from them.