Kames High Yield Global Bond Fund
May 2017 review
For professional investors only
07 June 2017
Performance
In May the Kames High Yield Global Bond Fund delivered a solid positive total return of 0.85%, against
the sector median 0.70%. Year-to-date the Fund has returned 4.01%, ahead of the median of 3.53%.
Although clearly we always aim to do so, we are particularly pleased to outperform the peer group
median as we have managed this despite largely resisting the siren calls of CCC, distressed, and EM
high yield debt. These segments of the market have rallied strongly so far in 2017, however we maintain
they represent poor longer-term value on a risk/reward basis.
Phil Milburn
Co-manager of the Kames
High Yield Bond Fund
David Ennett
Co-manager of the Kames
High Yield Bond Fund
Jack Holmes
Support manager of the
Kames High Yield Bond
Fund
As has been the case for the last 2 months – indeed 10 years - the US and European high yield markets
produced almost identical total returns during May. In the US, CCC-rated credit again outperformed on
absolute terms, with BB and B-rated credit about even as credit spreads and Treasury yields both
compressed. In Europe, gains were led by single-B credits, with CCCs lagging the higher quality
segments of the market, despite the risk rally.
Of note during May was the marked underperformance of emerging market high yield. This was driven
by the latest corruption scandal in Brazil directly impacting beef producer JBS as well as other Brazilian
corporates such as Petrobras and Odebrecht. As markets have become more compressed in valuation,
we expect to see more and more of this, where credit and sector selection play an increasingly important
role as opposed to the more beta-driven moves of the last 12 months or so.
Market commentary
In Europe, Emmanuel Macron’s resounding victory in the French presidential election provided the
setting for the market’s strong tone. The relief was palpable as the market’s preferred centrist candidate
won, with sentiment further boosted by a steady stream of positive macro data out of Europe. In the UK,
PM Theresa May called a snap election for June, seeking an increased majority to help her manage the
Brexit negotiation process. Markets were relaxed about yet another political event as they immediately
discounted the possibility of a Labour win. The degree to which voters are as willing to play their part in a
coronation remains to be seen; however the polls and bookmakers suggest a Tory win remains highly
likely.
Such was the magnitude of Macron’s victory that it was even noticed in the United States, where markets
also took a shine to the lowering of political risk and again, the strength of recent data continued to
suggest the recovery was continuing unabated. US markets were dampened slightly by the pull-back in
oil prices, but overall the market continued its grind tighter with other sectors performing well, most
notably the healthcare segment which partially reversed some of its recent underperformance.
To our regular readers there may seem to be some conflict between our cautious positioning and the
positive and improving world we often describe. To be clear, this is not because we have turned negative
on the world around us, but rather we are mindful of the relationship between outlook and valuation.
When the market is as compressed as it is, there is a significant opportunity to tailor portfolios to take
exactly the risks and exposures we choose with minimal loss in yields. Given the opportunity cost of
higher quality is currently very low, we think investors are best served by us managing funds in such a
way. We eagerly await the opportunities that a future volatility spike should throw our way – patience is
vital during this time. The time to embrace beta is not when everyone feels it the obvious thing to do –
rather quite the contrary. In the interim, the Fund still possesses significant carry and investors can
benefit from this as we remain vigilant on protecting their downside risk. The key is to stay invested as
you can’t day-trade carry!
Fund activity
Fund activity was relatively muted during the month as the continued lack of volatility has not presented
swathes of opportunity and we remain happy with our core holdings.
The Fund did take profits by trimming positions in a number of names as the market snapped tighter
during the month. This included selling around half of our Goldman Sachs subordinated debt holding as
the valuation became less compelling and we sought to balance bank risk, which had increased
elsewhere in the previous month. To keep position sizes at optimal levels, we also trimmed some higher
risk positions that had rallied very strongly in recent months. Among these was one of our few energy
exposures, DEA, where our anticipation for further issuance coupled with its recent strong capital price
appreciation led us to sell a small portion to allow ourselves room to add upon new issuance or market
volatility. In a similar vein, we also sold small amounts of our holding in e-Dreams Odigeo, Europe’s
leading online travel agent. This gave us scope to increase the position again on weakness, as we are
mindful of the inherent volatility in such names. Cash proceeds were redeployed in topping up some
lower-beta credits that had lagged the strong market. These included vertically-integrated entertainment
conglomerate Live Nation, and Ultra Resources, where the dip in oil prices gave us an opportunity to add
attractively-priced risk in one of our favoured names in the energy sector.
Earnings season meant that the primary market was a little less busy, and much that did come was
simply not attractive in terms of risk profile, duration, or pricing. Our participation in May was limited to an
existing holding that was seeking to refinance debt (Burger King) and an old favourite of the high yield
market, Iron Mountain.
Iron Mountain is an archetypal ‘good fit’ for high yield bond investors. The company provides physical
storage of archived documents for corporate and government clients throughout the world, as well as a
range of ancillary services. It’s not the most glamorous of businesses - the best investments rarely are –
but it provides a vital service for organisations who are required to keep physical records of their
activities. The cash flow profile of the company is very stable, non-cyclical, and predictable; all things we
like to see in a company. Customers also tend to stick with them, with the average box having been
physically stored by them for around 15 years. In short, Iron Mountain illustrates what we are looking to
do in the Fund at the moment with valuations more compressed - that is concentrate on high-quality cash
flows to provide secure income for our clients and manage the downside risk ever-present in high yield
markets.
David Ennett
Top 10 issuer holdings at 31 May 2017
1. Center Parcs
Center Parcs is an owner and operator of five forest holiday villages located in the UK that are popular
with families for short breaks. Management has a strong track record of growing revenues while
maintaining occupancy, and it is executing a number of plans to upgrade the resorts, which is expected
to further boost profitability. These bonds are secured on the property assets themselves, which we
believe are worth approximately 1.7x as much as the face value of the debt outstanding, significantly
limiting downside risk. The bonds are now call constrained but offer reasonable carry until they are used
as a source of funds for other opportunities.
2. Virgin Media
Virgin Media is a safe and steady credit that has been a longer-term acquisition target of Vodafone.
Since Liberty’s takeover we have seen robust price increases and solid customer growth and we expect
this to continue. Cable has a structural speed advantage over rival broadband offerings and stands to
benefit from higher broadband and TV penetration in the UK as free-to-air TV market share falls. In
February 2017 the company finally decided to exchange its 2021 bonds, which have a tighter restricted
payments covenant on them than other bonds in the structure. The exchange terms are generous and
the new bond which we received offered an uplift of 0.5% coupon per year and 5 points higher call price
in 2021.
3. Numericable/SFR
Numericable/SFR is the number-two telecommunications provider in France after Orange. The group is
majority owned by the Altice Group. The rationale in combining SFR and Numericable was to create a
‘French champion’ in high-speed telecommunications. By combining the fixed and mobile operations,
Altice believes there can be €1 billion of cash flow synergies and EBITDA margins of 45% (from 27%
SFR standalone margins at takeover). Management has done a very good job of extracting value thus
far, with margins currently at 35%. Synergies aside, this remains a self-help story, with both penetration
and revenue-generating units per subscriber at very low levels versus European cable peers.
4. MGM
MGM Resorts International operates a wide portfolio of resort/casino hotel brands including Bellagio and
The Mirage. MGM also owns a majority stake in the hotel property leasing company, as well as interests
in the MGM Macau resort and CityCenter in Las Vegas. With visitor numbers in Las Vegas picking up,
and little new hotel capacity coming on stream, MGM is well placed to capitalise on these favourable
fundamentals. Furthermore, Macau appears to have bottomed out and MGM has some regional US
properties going.
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5. First Data Corporation
First Data Corporation provides infrastructure in the payments processing industry. It is the largest
company of its kind and handles 45% of US credit and debit transactions. The company had a
chequered past from having been an LBO at the peak of the market in 2007; since then debt has been
restructured and reduced culminating in a stock market listing in October 2015. We have always liked
the fundamentals of the company, but had an issue with the over-leveraged balance sheet almost a
decade ago. The balance sheet issues are now resolved and the credit still offers value as management
look to reduce debt further via organic cash flow generation.
6. IGT
International Game Technology (IGT) provides the infrastructure for various gaming industries. This
ranges from slot machines to the technology underlying lotteries. IGT is also involved in various lottery
operating concessions. We like the long-term contracted nature of the concessions part of the business
and the geographical diversity of the whole company.
7. Navient
Navient is a specialist in student loan management, servicing and asset recovery. Navient’s main asset
is the receivables book spun out of Sallie Mae, which provides the assets and cash flows backing both
some ABS securities and our unsecured bonds. Delinquency rates do exhibit a little volatility but even
under punitive assumptions our bonds are well covered. Upside could also arise once Navient is allowed
to start originating loans too, rather than just purchasing secondary market portfolios.
8. Service Corporation International (SCI)
Service Corporation International is a leading provider of death care services, i.e. funeral service
locations, cemeteries and crematoria, as well as pre-arranged funeral services. The death care industry
is characterised by modest but predictable growth and has high barriers to entry. Industry revenue is set
to benefit from a demographic tailwind over the next decade as the ‘baby boom’ generation approaches
retirement (and death). Since acquiring its nearest rival in 2013, SCI has, and will continue to be, well
positioned to take advantage of its scale benefits.
9. Unitymedia
Unitymedia is the second-largest cable company in Germany and is owned by Liberty Global.
Unitymedia has already passed through a large capital expenditure cycle, and this is not likely to pick up
again for a few years, which means the company is highly cash generative. The company exhibits slowly
growing and reasonably predictable revenues, as well as high EBITDA margins. Leverage is expected to
be maintained in the 4–5x range, and the bonds contain covenants that limit additional debt accordingly.
10. Medical Properties Trust
Medical Properties Trust is a healthcare REIT and the second largest US-based owner of for-profit
hospital beds. It owns over 240 healthcare properties and is primarily focused on acute care hospitals.
MPW operate across 25 US states and Western Europe. The company leases its facilities to a diversified
group of hospital operating companies under long-term triple-net leases with tenants maintaining the
properties and bearing the operating costs. The business model alludes itself to steady rental income
with annual rent escalators linked to inflation. With a strong credit profile and large asset base we view
MPW as a steady core holding.
*Source: Lipper, as at 31 May 2017. NAV to NAV, noon prices, income reinvested, net of ongoing charges, excluding entry or
exit charges. Dollar B Income share class (B shares from 21/04/2010).
For Professional Clients only and not to be distributed to or relied upon by retail clients.
Past performance is not a guide to future performance. Performance shown is net of charges and gross of tax. Outcomes, including
the payment of income, are not guaranteed.
Opinions expressed represent our understanding of the current and historical positions of the market and are not an investment
recommendation or advice. Any securities and related trading strategies referenced may or may not be held/used in any
strategy/portfolio. Any Opinions and/or example trades/securities are only present for the purposes of promoting Kames Capital's
investment management capabilities. Sources, both internal and external, used are deemed reliable by Kames Capital at the time of
writing.
Fund charges are deducted from capital which has the effect of increasing income distributions but constraining capital growth.
All data is sourced to Kames Capital unless otherwise stated. The document is accurate at the time of writing but is subject to change
without notice.
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jurisdictions other than those where the fund(s) is/are authorised for distribution.
The High Yield Global Bond Fund is currently authorised for distribution in UK, Channel Islands, Ireland, Luxembourg; Switzerland,
Malta, Germany, Austria, the Netherlands, Spain, Belgium, Sweden and Italy. Not all available share classes are registered in every
country. Refer to the full prospectus for details.
For investors in Austria, Germany, Luxembourg, Malta, the Netherlands, Portugal, Spain, Sweden and Professional/Qualified investors
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available free of charge and links to them may be found at www.kamescapital.com
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Agent in Switzerland, CACEIS (SA) Switzerland, Chemin de Precossy 7-9, CH-1260 Nyon / VD, Suisse, Phone: +41 22 360 94 00,
Fax: +41 22 360 94 60.
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