Objective and Strategy
Artisan High Income seeks to provide total return through a combination of current income and capital appreciation. They invest in a global portfolio of high yield corporate bonds and secured and unsecured loans. They pursue issuers with high quality business models that have compelling risk-adjusted return characteristics.
They highlight four “primary pillars” of their discipline:
Business Quality, including both the firm’s business model and the health of the industry.
Financial Strength and Flexibility, an inquiry strongly conditioned by the firm’s “history and trend of free cash flow generation.”
Downside Analysis. Their discussion here is worth quoting in full: “The team believes that credit instruments by their nature have an asymmetric risk profile. The risk of loss is often greater than the potential for gain, particularly when looking at below investment grade issuers. The team seeks to manage this risk with what it believes to be conservative financial projections that account for industry position, competitive dynamics and positioning within the capital structure.”
Value Identification, including issues of credit improvement, relative value, catalysts for business improvement and “potential value stemming from market or industry dislocations.”
The portfolio is organized around high conviction core positions (20-60% of assets), “spread” positions where the team fundamentally disagrees with the consensus view (10-50%) and opportunistic positions which might be short-term opportunities triggered by public events that other investors have not been able to digest and respond to (10-30%).
Artisan Partners, L.P. Artisan is a remarkable operation. They advise the 14 Artisan funds (all of which have a retail (Investor) share class since its previously institutional emerging markets fund advisor share class was redesignated in February.), as well as a number of separate accounts. The firm has managed to amass over $105 billion in assets under management, of which approximately $61 billion are in their mutual funds. Despite that, they have a very good track record for closing their funds and, less visibly, their separate account strategies while they’re still nimble. Seven of the firm’s 14 funds are closed to new investors, as of July 2014. Their management teams are stable, autonomous and invest heavily in their own funds.
Bryan C. Krug. Mr. Krug joined Artisan in December 2013. From 2001 until joining Artisan, Mr. Krug worked for Waddell & Reed and, from 2006, managed their Ivy High Income Fund (WHIAX). Mr. Krug leads Artisan’s Kansas City-based Credit Team. His work is supported by three analysts (Joanna Booth, Josh Basler and Scott Duba). Mr. Krug interviewed between 40 and 50 candidates in his first months at Artisan and seems somewhere between upbeat and giddy (well, to the extent fixed-income guys ever get giddy) at the personal and professional strengths of the folks he’s hired.
Strategy capacity and closure
There’s no preset capacity estimate. Mr. Krug makes two points concerning the issue. First, he’s successfully managed $10 billion in this strategy at his previous fund. Second, he’s dedicated to being an investment organization first and foremost; if at any point market changes or investor inflows threaten his ability to benefit his investors, he’ll close the fund. Artisan Partners has a long record of supporting their managers’ decision to do just that.
Management’s Stake in the Fund
Not yet disclosed. In general, Artisans staff and directors have invested between hundreds of thousands to millions of their own dollars in the Artisan complex.
March 19, 2014
1.25% after waivers on assets of $300 million, as of July 2014. There’s also a 2.0% redemption fee on shares held under 90 days.
There is a real question about whether mid 2014 is a good time to begin investing in high yield bonds. Skeptics point to four factors:
- Yields on junk bonds are at or near record lows (see “Junk bond yields at new and terrifying lows,” 06/24/2014)
- The spread from junk and investment grade bonds, that is, the addition income you receive for investing in a troubled issuer, is at or near record lows (“New record low,” 06/17/2014).
- Demand for junk is at or near record highs.
- Issuance of new junk – sometimes stuff being rushed to market to help fatten the hogs – is at or near record highs. Worried about high demand and low standards, Fed chair Janet Yellen allowed that “High-yield bonds have certainly caught our attention.” The junk market immediately rallied on the warning, with yields falling even lower (“Yellen’s risky debt warning leads to rally in risky debt,” 06/20/2014).
All of that led the estimable John Waggoner to announce that it’s “Time to sell your junk” (06/26/2014.).
None of that comes as news to Bryan Krug. His fund attracted nearly $300 million in three months and, as of late June, he reported that the portfolio was fully invested. He makes two arguments in favor of Artisan’s new fund:
First. Pricing in high yield debt is remarkably inefficient, so that even in richly valuable markets there are exploitable pockets of mispricing. “[W]e believe there is no shortage of inefficiencies … the market is innately complex and securities are frequently mispriced, which benefits those investors who are willing to roll up their sleeves and perform detailed, bottom-up analysis.” The market’s overall valuation is important primarily if you’re invested in a passive vehicle.
Second. High yield and loans do surprisingly well in many apparently hostile environments. In the past quarter century, there have been 16 sharp moves up in interest rates (more than 70 bps in a quarter); high yield bonds have returned, on average, 2.5% during those quarters and leveraged loans returned 3.9%. Even if we exclude the colossal run-up in the second quarter of 2009 (the turn off the March market bottom, where both groups gained over 20% in three months) returns for both groups are positive, though smaller.
Returns for investment grades bonds were, on average, notably negative. Being careful about the quality of the underlying business makes a huge difference. In 2008 Mr. Krug posted top tier results not because his bonds held up but because they didn’t go to zero. “We avoided permanent loss of capital by investing in better businesses, often asset-light firms with substantial, undervalued intellectual property.” There were, he says, no high fives that year but considerable relief that they contained the worst of the damage.
The fund has the flexibility of investing elsewhere in a firm’s capital structure, particularly in secured and unsecured loans. As of late June, those loans occupied about a third of the portfolio. That’s nearly twice the amount that he has, over the long term, committed to such defensive positions. His experience, concern for quality, and ability to shift has allowed his funds to weave their way through several tricky markets: over the past five years, his fund outperformed in all three quarters when the high yield group lost money and all four in which the broad bond market did. Indeed, he posted gains in three of the four quarters in which the bond market fell.
If you decide that you want to increase your exposure to such investments, there are few safer bets than Artisan. Artisan’s managers are organized into six autonomous teams, each with responsibility for its own portfolios and personnel. The teams are united by four characteristics:
- pervasive alignment of interests with their shareholders – managers, analysts and directors are all deeply invested in their funds, the managers have and have frequently exercised the right to close funds and other manifestations of their strategies, the partners own the firm and the teams are exceedingly stable.
- price sensitivity – Mr. Krug reports Artisan’s “firm believe that margins of safety should not be compromised,” which reflects the firm-wide ethos as well.
- a careful, articulate strategy for portfolio weightings – the funds generally have clear criteria for the size of initial positions in the portfolio, the upsizing of those positions with time and their eventual elimination, and
- uniformly high levels of talent – Artisan interviews a lot of potential managers each year, but only hires managers who they believe will be “category killers.”
Those factors have created a tradition of consistent excellence across the Artisan family. By way of illustration:
- Eleven of Artisan’s 14 retail funds are old enough to have Morningstar ratings. Eight of those funds have earned four or five stars.
- Ten of the 11 have been recognized as “Silver” or “Gold” funds by Morningstar’s analysts.
- Artisan teams have been nominated for Morningstar’s “manager of the year” award nine times in the past 15 years; they’ve won four times.
And none are weak funds, though some do get out of step with the market from time to time. That, by the way, is a good thing.
In general, it’s unwise to make long-term decisions based on short-term factors. While valuation concerns are worrisome and might reasonably influence your decisions about new money in your portfolio, it makes no sense to declare high yield off limits because of valuation concerns any more than it would be to declare that equities or investment grade bonds (both of which might be less attractively valued than high income securities) have no place in your portfolio. Caution is sensible. Relying on an experienced manager is sensible. Artisan High Income is sensible. I’d consider it.
Artisan High Income. There’s a nice six page research report, Recognizing Opportunities in Non-Investment Grade Credit, available there.
By way of disclosure: while the Observer has no financial relationship with or interest in Artisan, I do own shares of two of the Artisan funds (Small Cap Value ARTVX and International Value ARTKX) and have done so since the funds’ inception.© Mutual Fund Observer, 2014. All rights reserved. The information here reflects publicly available information current at the time of publication. For reprint/e-rights contact us.