RIA Supplement - High yield - November 2019

HIGH YIELD

IS HIGH YIELD ON A ROLL... ...AND WHERE CAN OPPORTUNITIES STILL BE FOUND? UNCOVERING HIGH YIELD GEMS NOVEMBER 2019

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ADVISOR VIEWS WHERE YOU ARE FINDING THE BEST RETURNS

RISK OR RETURN

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HIGH YIELD

ROLLING WITH THE RISKS Can the good times continue to roll on for high yield? And if not, what happens next? Those are two questions many advisors are likely pondering right now, with the $1.2 trillion asset class at something of a crossroads. On the one hand, growth has slowed, defaults are now rising, recession risks loom, and calamities like the WeWork saga deservedly dominate headlines.

And yet, spreads have remained fairly tame, buoyed by a still-strong consumer and a dovish Federal Reserve. So, what should investors do?

One solution may be to get active – and highly selective – when looking at high yield. You can turn to page four to find out more.

In addition to those aforementioned risks, however, experts have been closely watching BBB rated bonds, the highest tranche of investment grade (page 12). In the past few years, BBB rated bonds have come to represent more than half of the investment grade universe, and the riskiest BBB issuers are now far bigger than the entire high yield universe combined.

That could be a problem, since the BBB universe is dominated by a handful of highprofile giants, like General Motors, and any major downgrades could well disrupt and crowd out the high yield sector. But do these risks offer some opportunities for active managers? And

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IS HIGH YIELD ON A ROLL? WHERE OPPORTUNITIES CAN BE FOUND TRASH OR TREASURE? UNCOVERING HIGH YIELD GEMS ADVISOR VIEWS FINDING THE BEST RETURNS

how real is the ‘BBB threat’? We asked a number of leading experts to find out.

And we finish by asking three RIAs about their views on high yield – and how they’re positioning clients’ portfolios (page 20). The sector has proven to remarkably resilient, some note, and is still worth allocating to. But others are scaling back their exposure or avoiding high yield altogether, believing that it acts more like equities – with lower returns – than traditional fixed income investing. Enjoy reading.

ALEX STEGER

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EDITOR CITYWIRE asteger@citywireusa.com (+1) 646 532 2961 3

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HIGH YIELD

WILL THE GOOD TIMES CONTINUE TO ROLL FOR HIGH YIELD INVESTORS? The high yield market is on course for a bumper year and select opportunities remain

JENNIFER HILL

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Investors in high yield debt are on track for their best year since 2016. The iShares iBoxx High Yield Corporate Bond ETF is up almost 12% in the year to date – within touching distance of a 13.9% total return during 2016 as a whole. The strong showing stands in stark contrast to a loss of 1.9% last year and is almost double 2017’s gain of 6.1%.

Will the good times continue to roll for high yield investors? They should if the US Federal Reserve gets its way. In October, it reduced the benchmark US interest rate for the third time this year in an effort to boost the economy as the US-China trade war and a global economic slowdown threaten to derail growth. Its dovish stance is a volte-face from last year when it was firmly in rate raising mode.

‘In 2018, the Fed was trying to get out of the

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I IMAGINE FED CHAIR [JEROME] POWELL IN LATE DECEMBER USING MICHAEL CORLEONE’S LINE IN THE GODFATHER: PART III: “JUST WHEN I THOUGHT I WAS OUT, THEY PULL ME BACK IN!” BILL ZOX DIAMOND HILL CAPITAL MANAGEMENT

HIGH YIELD

business of suppressing volatility in risk assets like stocks and high yield bonds,’ said Bill Zox, chief investment officer for fixed income at Diamond Hill Capital Management.

‘Risk assets started to protest in the fourth quarter and the Fed largely ignored it. As of Christmas eve, the S&P 500 was down nearly 20%, the Russell 2000 was down more than 26% and high yield [as measured by the ICE BofAML US High Yield index] was down more than 5% from their respective peaks.

‘Although the Fed was trying to get out of the business of suppressing volatility, I imagine Fed

chair [Jerome] Powell in late December using Michael Corleone’s line in The Godfather: Part III: “Just when I thought I was out, they pull me back in!” ‘To say the Fed is back in the business of suppressing volatility is an understatement.

The Fed has completely capitulated to the financial markets.’

While the Fed made it clear last month that its rate cutting campaign has likely come to an end for now – Powell told reporters that the current stance was ‘appropriate’ – it still seems firmly entrenched in volatility suppression mode.

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THE CASE FOR HIGH YIELD IN A WEAKENING ECONOMY ANDREW FELTUS CO-DIRECTOR OF HIGH YIELD AMUNDI PIONEER KENNETH MONAGHAN CO-DIRECTOR OF HIGH YIELD AMUNDI PIONEER

Q. HIGH YIELD IS ONE OF THE FEW REMAINING ASSET CLASSES WITH DECENT YIELDS, BUT ECONOMIC GROWTH IS WEAKENING. IS THE SECTOR FRAUGHT WITH RISK? Andy: Fraught with risk? No! At this stage of the economic cycle, are the waters more challenging to navigate? Of course! The global economy is dominated by dovish central banks supporting loose financial conditions. High yield fundamentals remain healthy and the outlook for defaults is benign. We are not seeing any of the aggressive borrowing behavior we saw prior to the 2008/2009 recession.

While we’re seeing a synchronized deceleration in the global economy, it should hit a bottom in the first half of 2020, followed by slow economic growth in most advanced economies throughout next year. High yield spreads are relatively tight, and certain high yield sectors, such as energy, are weak. We expect market volatility tied to trade war headlines, although volatility creates both risks and potential opportunities. Barring any material change in our macro outlook, the picture is supportive for a selective investment approach to the asset class. Longer term, there’s a strong case for an allocation to US high yield and global high yield.

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Q. WHAT ARE THE MAJOR RISKS IN HIGH YIELD? Ken: An escalation of trade tensions is the one risk we are closely monitoring, as a full-blown trade war contagion would affect personal consumption, hurt the service sector, and put even more pressure on manufacturing. In this scenario, we would expect a spike in premia. Of course, a broad, comprehensive settlement of the US-China trade war, which we are not expecting, could lead to stronger economic growth in 2020, in which case government bond yields would rebound. The higher coupons and shorter average duration of high yield bonds should provide more downside protection than investment grade corporate bonds or government bonds, which would be more severely impacted.

We are cautious on retail and energy, particularly exploration-and-production and energy services companies. Both industries have a significant number of companies under pressure. We don’t see an easy solution for many distressed energy companies. The retail segment continues to struggle with secular changes. Still, the retail sector is one of the bestperforming sectors year to date. We always remind our investment team that to perform well over time an investor needs to be willing to sell the assets they have loved and buy the assets they have hated.

Q. WHAT IS THE OUTLOOK FOR DEFAULTS? Andy: We think they are going to increase, albeit modestly. The distressed ratio, which is the share of high yield bonds trading at spreads larger than 1,000 basis points over treasuries, shows about 6% of high yield bonds by market value are trading at distressed

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levels, and about half of that is energy. These numbers are relatively low by historical standards.

The good news is that surveys conducted by the Federal Reserve and the European Central Bank show that, on average, banks are not significantly tightening standards applied to corporate loans. This is another positive indicator for defaults.

Q. THERE IS INCREASING DISPERSION BETWEEN THE RETURNS OF THE LOWEST RATED BONDS (CCC) VERSUS HIGHER RATED BONDS (B, BB). IS THIS A WARNING SIGN FOR THE BROADER HIGH YIELD MARKET? Andy: Given the underperformance of CCCs, one would think that CCCs would be a great place to look for bargains! Unfortunately, when you look closely, you find that many CCCs are weak credits in troubled sectors, particularly energy. Because so much of the underperformance of the CCC portion of the market reflects sector-specific risk, we do not think that CCC performance foreshadows major high yield credit problems. In a high dispersion environment such as the current one, idiosyncratic price drivers are key market movers. Sector and security selection can create more value when bond prices and yields move in response to idiosyncratic factors.

Q. WHERE ARE THE OPPORTUNITIES IN GLOBAL HIGH YIELD? Ken: When considering global high yield, US high yield remains the largest component of the global high yield market, at 60%, while European high yield and emerging markets corporate high yield represent around 20% each. Looking at the relative annual performance of those three components of the global high yield market, US high yield is rarely the winner. A global strategy can allow a manager to pivot from one submarket of the global high yield market to another in search

of return potential. For example, fundamental and technical trends have been decoupling this year in both the European Union and the US, with opportunities emerging in Europe. Fundamentals appear healthier in Europe than the US, with use of corporate leverage lower. This is despite weak earnings growth for European companies.

The European high yield market is also more defensive than the US, with more BBs and fewer CCCs. In addition, Europe can offer interesting investment opportunities in “rising stars” – high yield companies with the potential for upgrades to investment grade. In Europe, this group includes certain subordinated peripheral issuers.

Q. HIGH YIELD IS MORE VULNERABLE TO LIQUIDITY RISK THAN OTHER FIXED INCOME SECTORS. HOW SHOULD INVESTORS THINK ABOUT THIS? Andy: So far this year there has been no material deterioration of liquidity conditions in high yield markets, but liquidity strains could arise in a market sell-off, and it is worth noting that the Eiropean Union is typically less liquid than the US. In our opinion, it is key for high yield investors to balance their portfolios with a mix of liquid and less liquid holdings. Active managers have tools at their disposal to deal with a liquidity crisis, including liquidity buffers and constant monitoring of market and investor liquidity.

Q. IS ESG A FACTOR IN THE HIGH YIELD SECTOR? Ken: We are getting more questions from clients about high yield and ESG, and we expect interest in high yield ESG strategies should increase. Amundi has made a large investment in ESG and has a large team of ESG specialists. We consider ESG factors as part of the fundamental analysis we conduct on each security we own.

Important Information: The views expressed regarding market and economic trends are those of the authors and not necessarily Amundi Pioneer Asset Management, and are subject to change at any time based on market and other conditions and there can be no assurances that countries, markets or sectors will perform as expected. These views should not be relied upon as investment advice, as securities recommendations, or as an indication of trading on behalf of any Amundi Pioneer Asset Management product. There is no guarantee that market forecasts discussed will be realized or that these trends will continue. Investments involve certain risks, including political and currency risks. Investment return and principal value may go down as well as up and could result in the loss of all capital invested. This material does not constitute an offer to buy or a solicitation to sell any units of any investment fund or any services. Amundi Pioneer Asset Management is the US business of the Amundi Asset Management group of companies.

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HIGH YIELD

‘First, the bond market is not discounting a fourth rate cut anytime soon,’ said Zox. ‘Second, Powell took rate hikes off the table unless there is a significant and persistent increase in inflation. Market participants are still confident the Fed will cut if the bond market calls for it. The bond market may be data dependent, but the Fed is market dependent.’

Is a reasonably strong economy and supportive Fed a good backdrop for the high yield market?

‘It certainly has been, but more due to declining interest rates than improving corporate fundamentals,’ added Zox. ‘Corporate earnings growth has to reaccelerate to continue to propel the broader high yield market higher.’

ACTIVE MANAGEMENT

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HighTower Advisors sees US economic growth continuing to slow and exhibiting late cycle characteristics. However, while it believes the economy is late cycle and growth will remain elusive, it does not foresee an imminent recession. When considering high yield, it sees select opportunities for investors.

‘High yield as an asset class is more expensive than cheap compared to historical levels, but we do believe there are sub-segments of the market that can be attractive for the right investor,’ said Joseph Klein, an investment analyst.

‘Blanket high yield buying late cycle can be dangerous; investors need to remain selective and identify companies with strong fundamentals that are more defensive in nature.’

Seix Investment Advisors points to the bifurcation of the market and also believes active management will be key to navigating the inevitable end-of-cycle dynamics that will see the corporate credit sector ‘undergo significant volatility and re-pricing’.

‘While many investors moved up in quality last quarter, the amount of distressed bonds rose $4.2 billion month-over-month in September to $61.8 billion – 5.27% of the universe,’ said

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WOULD I WANT TO OWN A BBB BOND ETF? NO, PROBABLY NOT WHEN IT INCLUDES ALL THE EXCESSES AS WELL AS THE GOOD OPPORTUNITIES. THE GOOD OPPORTUNITIES ARE A SMALLER PERCENTAGE OF THAT MARKET MICHAEL KIRKPATRICK SEIX INVESTMENT ADVISORS managing director Michael Kirkpatrick.

‘That marked the highest amount of distressed bonds since July 2016 and triple the level of a year ago. The market has no patience for credit intensive stories, and bonds from these issuers have been punished disproportionately.

‘In the meantime, average yields moved lower. By the end of the third quarter, 43% of high yield bonds yielded less than 4%, according to ICE BofAML, but spreads on lower-rated issues widened with much less trading volume and much less liquidity.’

As long as the economy is moving along, Seix believes that idiosyncratic risk – the risk inherent in investing in a specific bond – is what investors and their advisers should be concerned about.

Against this backdrop, a good credit selection process is crucial in avoiding unattractive valuations and downgrade candidates.

HIGH YIELD

‘We don’t think investors are getting paid to take on a lot of duration risk, nor do we think they’re being paid to take on a tremendous amount of credit risk, but the nice thing about the high yield asset class is you typically benefit from the carry, and that the bonds mature. In many cases, if you pick the right bond, you can get taken out early, which can drive your total return.

‘Would I want to own a BBB bond ETF? No, probably not when it includes all the excesses as well as the good opportunities. The good opportunities are a smaller percentage of that market.’

CAPITAL PRESERVATION HighTower Advisors sees BB-rated bonds with shorter maturities (less than five years) as an opportunity, provided investors have a ‘hold to maturity’ mindset and retain their conviction when volatility rises before bonds mature.

Being unconvinced that corporate earnings growth will re-accelerate, Diamond Hill is focused on preserving capital until the credit cycle turns. It is substantially underweight leveraged buyouts and the CCC part of the market, and is cautious on BB stock as ‘others following the same playbook are bidding up many BBs to extreme overvaluations’.

‘Overpaying for quality can be just as problematic as excessive leverage,’ said Zox. ‘As a result, we are more focused on the B part of the market and, even in our high yield portfolios, the BBB part of the investment grade market. There is a wide array of risk/

reward opportunities in the high yield market and now is the time to focus more on capital preservation than outsized returns.’

Mellon believes a good opportunity remains in the high yield municipal bond market for investors with a long investment timeframe seeking a relatively high level of tax-free income.

That is being driven by strong demand from those living in parts of the country that have had their ability to deduct their state and local taxes from their federal tax bill curtailed.

‘States are relatively well positioned for an economic slowdown,’ said senior portfolio manager Jeff Burger. ‘Defaults remain relatively low and we believe that municipal credit quality is materially better than corporate credit quality which leads to a much lower probability of default.’

Others, however, are less convinced. MFS Investment Management believes that the sub-investment grade market in aggregate does not offer an attractive risk/reward payoff.

‘Investors are not being compensated for the level of risk presented in the market against overall soft fundamentals,’ said chief global strategist Rob Almeida.

Fundamentals are mixed, with lower quality and cyclical segments experiencing rising distressed ratios. While a recession may be avoided in the US, we anticipate continued pressure on vulnerable credits.’

Across its high yield and multi-sector portfolios, MFS is defensively positioned by being overweight BB/BBB issuers and underweight B/CCC-rated stock. ◊

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A DIFFERENTIATED APPROACH TO CREDIT INVESTING BRYAN KRUG PORTFOLIO MANAGER ARTISAN PARTNERS CREDIT TEAM What sets your approach apart from your peers’?

There are several aspects of our investment approach that are differentiated. First and foremost, is our commitment to fundamental research. We take a value investor’s approach to the below investment grade market, relying on our own in-depth fundamental credit research.

My team has focused coverage responsibilities with a teamimposed limit of 20 issuers per analyst, allowing us to go deeper and have a better understanding of the business and its drivers. As part of our research efforts, we talk with company management, suppliers, competitors, former employees and so on, to triangulate independently what’s happening with a company.

We also supplement our research with unconventional data sources—both public and private—to either verify or challenge our investment theses.

Another differentiator is our approach to position sizing. We believe a focused, high-conviction portfolio can generate consistent and repeatable outperformance over a full market cycle. As a

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result, we build a concentrated portfolio that allows our highest conviction names to meaningfully drive performance.

And lastly, our flexibility to invest across the capital structure— whether in bonds or loans—based on relative value is unique. We tend to think on a risk-adjusted basis, and by investing across the capital structure, we can drive different outcomes among securities of the same company.

Given your ability to flex across bonds and loans, how do you determine where to be positioned within a company’s capital structure?

Based on our independent research, we form a fundamental view on the business’s trajectory.

With that view, we anticipate how financial leverage will work through different parts of the capital structure. With each capital structure, we assess the maturity profile and the opportunities for the company to enhance its capital structure by performing a capital market transaction—and then we identify a piece of debt with the best risk-adjusted return potential.

In general, if we’re more constructive on material credit improvement, we’re likely going to invest in the part of the capital structure that will experience the most spread compression.

The portfolio has held up well in risk-off environments. How have you mitigated risk and protected the downside?

I’ve managed through several different market cycles over my career, and I’ve learned the best way to win is often by not losing.

We’re always trying to think about where we could go wrong in our analysis—which means using conservative financial projections that account for an issuer’s industry position as well as the competitive dynamics and positioning within the capital structure.

Similarly, being value-oriented, capital structure-agnostic investors has been a big contributor to our downside protection story. The ability to move into more senior positions in the capital structure based on valuations—combined with our emphasis on quality— has allowed our portfolio to weather several difficult market environments over the years. In general, this flexibility has resulted in a lower level of volatility relative to the index with a fraction of the market’s drawdown during selloffs.

How do credit ratings factor into your investment philosophy and process?

We believe the marketplace places a disproportional emphasis on ratings, which creates an opportunity for ratings agnostic investors like us. Because we rely

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on our own in-depth fundamental research to determine the companies’ creditworthiness, our portfolio can look meaningfully different than the broader index. In general, we’ll own fewer capitalintensive issuers and more highermultiple businesses, often found in the software, insurance and media sectors. These businesses often have predictable cash flows, low capital expenditures and unique deleveraging capabilities but are generally disliked by rating agencies. In our view, ratings agencies tend to overemphasize hard assets and underemphasize cash flow generated by assets such as intellectual property and technology.

How do you view the market environment today?

Defining features of the market environment over the last 12 months have been growing risk aversion and the persistent flight to quality. Higher-rated credits have rallied, as increased uncertainty around the global economy’s direction has pushed global interest rates to new lows and high yield spreads near cyclical tights. At the same time, extreme investor caution has resulted in an almost wholesale flight of capital away from lower-rated segments. In

other words, this year’s doubledigit returns in high yield have occurred despite a limited appetite for risk, which is a truly unique phenomenon.

In our view, though, the economic environment remains far more resilient than the extreme pessimism being priced into safe-haven assets. We continue to remain constructive on our opportunity set given the expectations for relatively limited defaults, a favorable supply/ demand environment and the tailwind of supportive monetary policy. We certainly recognize valuations for credit markets in aggregate are approaching the tight end of their historical range, but overarching uncertainty has resulted in a pronounced decoupling of risk across industries, credit quality and capital structures.

This increased dispersion bodes well for credit pickers like us.

How you are positioned given this growing divergence across the credit landscape?

As it stands today, nearly one third of the constituents in the ICE BofAML US High Yield Index trade with a yield less than 4.0%, making it increasingly difficult to justify the valuations for some of the highest quality bond segments.

As a result, we continue to move away from BB-rated risk, which has been the best performing high yield segment, but is also most vulnerable to interest-rate and extension risk at current levels. Instead, we favor B-rated and idiosyncratic CCC-rated opportunities. The indiscriminate selling at the lower rungs of the credit spectrum has increased the relative value of several CCCrated issuers with business models that are less sensitive to the economic cycle and credit metrics less volatile than peers’.

Similarly, the persistent return imbalance between bonds and loans this year has made valuations for floating-rate loans even more compelling. We are certainly aware the outlook for interest rates is likely lower, but we believe this is more than priced into valuations at current levels.

As a result, we’ve been allocating more to discounted leveraged loans and away from more ratesensitive high yield bonds. For high-quality credit risk, we believe B-rated loans can serve as a good proxy for BB-rated bonds. We’ve identified several investments where we’re able to pick up spread and capital structure seniority with almost identical loan-to-value metrics.

This material represents the views of Bryan Krug, portfolio manager of the Artisan High Income Strategy, as of 30 September 2019. The views and opinions expressed are based on current market conditions, which will fluctuate and those views are subject to change without notice. While the information contained herein is believed to be reliable, there no guarantee to the accuracy or completeness of any statement in the discussion. Any forecasts contained herein are for illustrative purposes only and are not to be relied upon as advice or interpreted as a recommendation. This material is provided for informational purposes without regard to your particular investment needs. This material shall not be construed as investment or tax advice on which you may rely for your investment decisions. Investors should consult their financial and tax adviser before making investments in order to determine the appropriateness of any investment product discussed herein. Credit investing involves risks. Fixed income securities carry interest rate risk and credit risk. In general, when interest rates rise, fixed income fund values fall and investors may lose principal value. High income securities (junk bonds) are fixed income instruments rated below investment grade. High income securities are speculative, have a higher degree of default risk than higher-rated bonds and may increase a portfolio’s volatility. Credit Quality ratings are from S&P and/or Moody’s. Ratings typically range from AAA (highest) to D (lowest) and are subject to change. Below investment grade bonds are bonds with a credit rating below investment grade (Baa3 or BBB-), as judged by the bond ratings assigned by one of the major rating agencies. Yield to worst (YTW) is the lowest potential yield that can be received on a bond without the issuer actually defaulting. Credit spread is the difference in yield between a U.S. Treasury bond and another debt security of the same maturity but different credit quality. ICE BofAML US High Yield Master II Index measures the performance of below investment grade $US-denominated corporate bonds publicly issued in the US market. ICE BofAML BBB US Corporate Index, ICE BofAML BB US High Yield, ICE BofAML Single-B US High Yield Index and ICE BofAML CCC & Lower US High Yield Index are subsets of ICE BofAML US High Yield Index. Source ICE Data Indices, LLC, used with permission. ICE Data Indices, LLC permits use of the ICE BofAML indices and related data on an “as is” basis, makes no warranties regarding same, does not guarantee the suitability, quality, accuracy, timeliness, and/or completeness of the ICE BofAML indices or any data included in, related to, or derived therefrom, assumes no liability in connection with the use of the foregoing, and does not sponsor, endorse, or recommend Artisan Partners or any of its products or services. Artisan Partners Limited Partnership is an investment adviser registered with the U.S. Securities and Exchange Commission. © 2019 Artisan Partners. All rights reserved.

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HIGH YIELD

INVESTMENT-GRADE TRASH OR HIGH-YIELD TREASURE? Investors are increasingly concerned about the sharp rise in BBB bonds, but one investor’s trash is another’s treasure, as we found out when we asked investment professionals to rate their view on a scale of one (most bearish) to 10 (most bullish)

JENNIFER HILL JOHN McCLAIN DIAMOND HILL CAPITAL MANAGEMENT PORTFOLIO MANAGER

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BBBs offer high yield returns with investment grade risks, according to John McClain, a portfolio manager at Diamond Hill Capital Management. His conviction level was higher in early 2019, but still stands at eight out of 10.

‘Headlines from the beginning of

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the year prophesizing a swath of downgrades from BBB issuers into high yield have been proven wrong,’ he said. ‘The difference today is rates are closer to fair value as opposed to a strong tailwind, but we believe high yield investors are still meaningfully compensated for selectively allocating to this off benchmark opportunity.’

He points to the crossover space (BBB to BB rated issuers) representing half of the total corporate bond market, with both ratings buckets having exploded in growth since the end of 2008 – BBBs by 275% and BBs by 116%.

‘The key takeaway is that the growth of these ratings buckets was voluntary leveraging by management teams,’ he said.

‘Interest rates have been low

HIGH YIELD

for a very long time and managers were rewarded handsomely by using debt for share buybacks, dividends and largescale M&A. Today, however, investors are focused on protecting balance sheets, thus managers of BBB firms are as well.’

The ‘up in quality’ trade has dominated most asset classes during 2019. High yield and investment grade are two distinct markets: investment grade trades on spread and high

INVESTORS ARE FOCUSED ON PROTECTING BALANCE SHEETS, THUS MANAGERS OF BBB FIRMS ARE AS WELL yield on dollar price.

‘Managers in one market frequently do not pay meaningful attention to the other,’ said McClain. ‘The opportunity sets should in theory overlap, but most managers are constrained to one market or the other.

‘This has manifested itself with BBs trading at extremely rich valuations while many BBBs are

MICHAEL KIRKPATRICK SEIX INVESTMENT ADVISORS MANAGING DIRECTOR

While mindful of the risks in BBB bonds, Michael Kirkpatrick, managing director of Seix Investment Advisors, rates his position as a seven out of ten.

‘The issuance in BBB space has broken records

trading at reasonable levels. The spread between the two ratings buckets is near its all-time low. BBBs have been treated like investment grade trash and should be viewed as a treasure for high yield investors.’

and that tends to precede an environment where underwriting standards deteriorate and potential excesses are developing, so investors in the BBB space need to be very selective,’ he said.

‘Active fixed income managers generally have the flexibility, agility and tools to pivot toward under-researched potential opportunities and relative values, especially as macro risks intensify and investment grade corporate debt issuers are downgraded.’

If a major issuer like Comcast or General Electric was downgraded to junk in this environment, he

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Ranked the #1 provider of multimanager investments by financial advisors At John Hancock Investment Management, we search the world to find proven portfolio teams with specialized expertise for every strategy we offer, then we apply robust investment oversight to ensure they continue to meet our uncompromising standards and serve the best interests of our shareholders.

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Investing involves risks, including the potential loss of principal. See the funds’ prospectuses for details.

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Howard C. Greene, CFA Jeffrey N. Given, CFA Manulife Investment Management JOHN HANCOCK BOND FUND

HIGH YIELD

MAJOR DOWNGRADES CAN CREATE POTENTIAL OPPORTUNITIES TO PICK UP SOME CHEAP BONDS would contend that the ‘technicals on high yield remain very strong’.

‘The high yield market has been shrinking,’ he said. ‘There hasn’t been a significant amount of issuance. The number of rising stars going out of high yield to investment grade are greater than the amount of fallen angels from investment grade down to high yield.’

In the nine months to end September, rising stars totaled $44 billion while

LEE MAJKRZAK HIGHTOWER ADVISORS DIRECTOR OF FIXED INCOME PORTFOLIO SOLUTIONS

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HighTower Advisors has become slightly more cautious on BBB bonds and rates its stance as a six out of 10 today compared to an eight out of 10 six months ago.

Lee Majkrzak, director of fixed income portfolio solutions, attributes HighTower’s current view to a combination of increased valuations, low default rates and a cautious outlook for the US economy.

‘With global interest rates at historic lows, demand for bonds with any significant yield has continued to rise,’

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fallen angels were only $5 billion. The net $39 billion that has left high yield this year because of rating changes, as well as reinvested coupon payments, bond maturities, calls and tenders, adds to a ‘very favorable backdrop’ for high yield.

‘In that scenario, as investment grade managers sell such names, I would expect other investment grade managers as well as high yield buyers to slowly get involved,’ said Kirkpatrick. ‘Major downgrades can create potential opportunities to pick up some cheap bonds. Of course, if a downgrade cycle were to include a lot of big issuers, you’d probably see some volatility in the high yield space, but that’s when you can get your best opportunities.’

WITH GLOBAL INTEREST RATES AT HISTORIC LOWS, DEMAND FOR BONDS WITH ANY SIGNIFICANT YIELD HAS CONTINUED TO RISE he said. ‘This has benefited corporate bonds as a whole, and more specifically lower-rated investment grade bonds and high yield.

Regardless of the credit rating, valuations have become more expensive.

‘Much like homeowners refinancing their mortgage, companies have taken advantage of the lengthy low rate environment by frequently returning to debt capital markets in order to lock in lower rates. BBB is the lowest investment grade

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rating, but historically presents a very low default risk to investors.

‘According to Moody’s annual default report, the five-year average default rate for Baa issuers [Moody’s equivalent to BBB] is only 1.46%. The risk of a downgrade is higher, as almost 8% of bonds will migrate from Baa to Ba in a five-year period.’

At $2.5 trillion, BBB debt is more than two times the size of the entire high yield market, and BBB issuers are more leveraged than they

COLLIN MARTIN CHARLES SCHWAB FIXED INCOME STRATEGIST

Charles Schwab is bearish on BBB bonds, but only modestly so with fixed income strategist Collin Martin ranking its view as a three out of 10.

‘With BBBs making up more than 50% of the investment grade market, downgrades to junk territory can pose a risk for the whole corporate bond market,’ he said. ‘With such a large amount of BBBs outstanding, is there enough high yield demand to absorb the fallen angels if we do get a wave of downgrades? If not, that would likely send spreads of all corporate bonds higher. We see this as the greatest risk of the BBB threat.’

The prices of those bonds that are running the risk of getting downgraded from BBB to junk are likely to decline in anticipation.

For advisors of more conservative investors whose bond holdings have been downgraded to BBB, this is a good time to review their holdings and make sure the risk being taken matches

have been in recent memory. However, Majkrzak does not foresee a systematic wave of downgrades from BBB to high yield.

‘There is a big difference between idiosyncratic downgrades, as we have seen this year with General Electric and Ford, and companies across all sectors getting downgraded on their business prospects and thereby their ability to pay off debt.

‘The couple of big downgrades we’ve seen this year have not been contagious absent a deeper earnings recession.’

WITH BBBS MAKING UP MORE THAN 50% OF THE INVESTMENT GRADE MARKET, DOWNGRADES TO JUNK TERRITORY CAN POSE A RISK FOR THE WHOLE CORPORATE BOND MARKET their risk tolerance. If you wouldn’t buy a bond today for a client, should they still be holding it?

‘This trend of more and more BBBs is important to investors because it means many passive investors are taking on more credit risk without even knowing it,’ said Martin. ‘For example, the credit quality of an index-tracking corporate bond ETF is much lower today than it was a decade ago. Investors who may be long-term holders of these funds may not realize that the funds have gotten riskier, while their risk tolerance may be unchanged.’

His guidance is to move up in quality in the investment grade corporate bond market, focusing on issues with ratings of A or above, or on mutual funds or ETFs that have a tilt towards bonds with A ratings or better. ◊

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LAND OF DISPERSION

By Ares Capital Management LLC, Sub-Advisor to Touchstone Credit Opportunities II Fund HUNTING YIELD AMID MARKET UNCERTAINTY The liquid sub-investment grade credit markets have continued to rally following a record-setting start to 2019. Through three quarters, returns for the high yield and leveraged loan asset classes have either met or exceeded full-year expectations. As the rally continues, the performance narrative has become decidedly bifurcated. Global monetary policy, economic and corporate earnings momentum and geopolitical volatility have contributed to a hunt for yield and market uncertainty. As a result, singlename dispersion has increased as individual credits are either coveted or ignored by investors. This trend presents a compelling scenario as the opportunity for alpha generation has increased, but the margin for error has narrowed.

This market insights piece highlights the rise of singlename dispersion in the sub-investment grade credit markets and addresses the opportunities and risks in an environment where the stakes have been raised.

CREDIT SELECTION MATTERS Credit markets in 2019 have evolved into a land of “haves” and “have-nots.” Individual credits have made significant moves relative to the market as investors react to various economic, fundamental and geopolitical headlines, while searching for income in an environment where the amount of negative yielding debt has reached record levels. Specific to the high yield market, this has resulted in the percentage of bonds trading outside of market levels to increase from 61% to 81%, and from 32% to 64% for CCCs, over the last 12 months.1 Both percentages are multiyear highs.

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High Yield has Transformed into a Land of “Haves” and “Have-Nots” Bonds Trading Outside of Market Levels1

This bifurcation is occurring in the leveraged loan market as well. While the average market price is approximately flat since February, implying a calm environment for investors purely seeking beta, the percentage of the market trading above par has increased from 4.8% to 26.5% as of September month-end.

Conversely, we’ve witnessed a growing cohort of leveraged loans drop below $90 recently, and in a rapid manner. According to data compiled

by Bloomberg, 53 leveraged loans in this cohort have declined by more than 10 percentage points in the last three months.2 While Consumer Discretionary and Energy companies comprise roughly half of this population, 10 unique industries represented within the group have experienced sharp price declines.

Bifurcation in the Leveraged Loan Market Leveraged Loan Market Prices

Source: Credit Suisse Leveraged Loan Index

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As a growing number of credits have exhibited dramatic moves relative to the market, industries have not experienced the same degree of bifurcation. In fact, industry-level dispersion within high yield and loan markets has dropped and remained below-average in 2019 and is currently below the five-year average for both asset classes.3 The one outlier to this trend is the Energy segment of the high yield market, which has underperformed substantially in recent months due to commodity price weakness. We believe these trends reflect the current economic and corporate fundamental environment and underscore the importance of active credit selection.

Industry Dispersion is on the Decline Sub-Investment Grade Credit Industry Dispersion

Source: Credit Suisse Leveraged Loan Index, ICE BAML HY Indices. Data as of September 30, 2019

INVESTORS IMPLICATIONS We believe increased single-name dispersion in the high yield and leveraged loan markets provide a robust opportunity set for active credit selection.

As the opportunity set has increased in 2019, so has the potential for differentiation amongst active managers via selecting “haves” and either avoiding or shorting “have-nots.”

We remain positive on the prospects for the high yield and leveraged loan markets as credit metrics are stable, market technicals are healthy and default rates remain below historical averages. We believe both markets remain a stable source of current income which potentially offer attractive yields relative to the broader liquid credit universe, particularly in an environment where the amount of negative yielding assets has exceeded $15 trillion.4 We believe that bouts of episodic volatility will continue as geopolitical headlines, central bank policy and decelerating corporate earnings influence investor sentiment, which grows increasingly wary as the current cycle elongates.

Overall, we seek to be agile and take advantage of increased single-name dispersion both directionally and across multiple asset classes where suitable.

BAML High Yield Strategy. Index level defined as bonds with an OAS of +/-100bps of overall index level. For CCCs, index level is defined as bonds with an OAS of +/- 400bps of the CCC index level. 2 Bloomberg. As of October 15, 2019. 3 ICE BAML HY Indices, Credit Suisse Leveraged Loan Index. Data as of September 30, 2019.

Bloomberg. As of September 30, 2019.

This article contains the current, good faith opinions of Ares Management Global Liquid Credit Team (“Ares”). It is meant for information purposes only and is not intended to present and should not be construed as any investment advice. It is neither a recommendation of an investment nor an offer to sell or a solicitation of an offer to purchase (or any marketing in connection therewith) any interest in Ares or any investment vehicles managed by Ares or its affiliates, the offer and/or sale of which can only be made by definitive offering documentation. No party should rely on the information set forth herein for investment purposes or otherwise. There is no guarantee that any projection, forecast or opinion in these materials will be realized. Past performance is neither indicative of, nor a guarantee of, future results. The views expressed herein may change at any time subsequent to the date of issue hereof. The information contained herein does not take into account any particular investment objectives, financial situations or needs and individual circumstances should be considered with investment professionals before making any decisions. This article may contain forward-looking statements. These are based upon a number of assumptions concerning future conditions that ultimately may prove to be inaccurate. Such forward-looking statements are subject to risks and uncertainties and may be affected by various factors that may cause actual results to differ materially from those in the forward-looking statements. Any forward-looking statements speak only as of the date they are made and Ares assumes no duty to and does not undertake to update forward-looking statements or any other information contained herein. Ares may make investment recommendations and decisions that are contrary to the views expressed herein and may sponsor and hold interests in investment vehicles that have holdings that are inconsistent with the views expressed herein. The document may not be copied, quoted, or referenced without Ares’ prior written consent. This may contain information obtained from third parties, including ratings from credit ratings agencies such as Standard & Poor’s.

Reproduction and distribution of third-party content in any form is prohibited except with the prior written permission of the applicable third party. Third party content providers do not guarantee the accuracy, completeness, timeliness or availability of any information, including ratings, and are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, or for the results obtained from the use of such content. THIRD PARTY CONTENT PROVIDERS GIVE NO EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE. THIRD PARTY CONTENT PROVIDERS SHALL NOT BE LIABLE FOR ANY DIRECT, INDIRECT, INCIDENTAL, EXEMPLARY, COMPENSATORY, PUNITIVE, SPECIAL OR CONSEQUENTIAL DAMAGES, COSTS, EXPENSES, LEGAL FEES, OR LOSSES (INCLUDING LOST INCOME OR PROFITS AND OPPORTUNITY COSTS OR LOSSES CAUSED BY NEGLIGENCE) IN CONNECTION WITH ANY USE OF THEIR CONTENT, INCLUDING RATINGS. This may contain information sourced from BofA Merrill Lynch, used with permission. BOFA MERRILL LYNCH IS LICENSING THE ICE BOFAML INDICES AND RELATED DATA “AS IS,” MAKES NO WARRANTIES REGARDING SAME, DOES NOT GUARANTEE THE SUITABILITY, QUALITY, ACCURACY, TIMELINESS, AND/OR COMPLETENESS OF THE ICE BOFAML INDICES OR ANY DATA INCLUDED IN, RELATED TO, OR DERIVED THEREFROM, ASSUMES NO LIABILITY IN CONNECTION WITH THEIR USE, AND DOES NOT SPONSOR, ENDORSE, OR RECOMMEND ARES MANAGEMENT, OR ANY OF ITS PRODUCTS OR SERVICES. Ares Capital Management II LLC serves as sub-advisor to the Touchstone Credit Opportunities II Fund. It is a wholly owned subsidiary of Ares Management LLC, which is a wholly owned subsidiary of Ares Management, Corporation, a publicly traded, leading global alternative asset manager. As sub-advisor, Ares Capital Management II LLC makes investment decisions for the Fund and also ensures compliance with the Fund’s investment policies and guidelines. Past performance is no guarantee of future results. Investment return and principal value of an investment in a fund will fluctuate so that investor’s shares, when redeemed, may be worth more or less than their original cost. Please consider the investment objectives, risks, charges and expenses of the fund carefully before investing. The prospectus and the summary prospectus contain this and other information about the fund. For a prospectus or a summary prospectus, contact your financial advisor or download and/or request one at TouchstoneInvestments.com/resources or call Touchstone at 800.638.8194. Please read the prospectus and/or summary prospectus carefully before investing. Touchstone Funds are distributed by Touchstone Securities, Inc.* Touchstone is a member of Western & Southern Financial Group. *A registered broker-dealer and member FINRA and SIPC. 1 4

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HIGH YIELD

ADVISOR VIEWS Jennifer Hill spoke to three registered investment advisors about their views on high yield and how they are positioning clients’ portfolios accordingly

MICHAEL KIRKPATRICK SEIX INVESTMENT ADVISORS

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Seix Investment Advisors believes the high yield market continues to offer a compelling opportunity to investors.

‘High yield fundamentals have shown remarkable resilience,’ said Michael Kirkpatrick, its managing director.

‘Leverage ratios remain stable.

Interest coverage remains more than sufficient, and high yield bond default rates are expected to remain below historical averages. Credit quality continues to improve.’

According to JP Morgan, rising stars (bonds that have been upgraded either to investment grade or a higher rating within the speculative spectrum) far

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outpaced fallen angels (bonds that were previously investment grade but have since been reduced to speculative grade) in the third quarter of this year.

During the sell-off in credit-intensive securities during that period, Seix closely reviewed its investment theses, especially in energy, and decided to sell certain underperforming issues, but maintained exposure to others that are ‘trading too low given likely outcomes’.

‘On the higher quality side, we are maintaining a credit barbell including an allocation to BBBs, which are attractive given their superior, generally non-call structures and relatively tight spreads to BBs,’ said Kirkpatrick.

‘While the market value of BBBs comprises a record share of the high yield market, we are very focused on avoiding companies that may end up going from BBB to BB. We have

HIGH YIELD

ON THE HIGHER QUALITY SIDE, WE ARE MAINTAINING A CREDIT BARBELL, INCLUDING AN ALLOCATION TO BBBs, WHICH ARE ATTRACTIVE GIVEN THEIR SUPERIOR, GENERALLY NON-CALL STRUCTURES AND RELATIVELY TIGHT SPREADS TO BBs been looking for potential opportunities to go from BBs, which are callable, into BBBs with better bond structure and valuations.’

Against that backdrop, he believes the next downgrade cycle could lead to a doubling of the overall size of the high yield market, given the current leverage cycle that has driven a surge in shareholder-friendly dividends, mergers and acquisitions, and stock buybacks.

Under its implied ratings analysis, around 55% of BBB debt would have a high yield rating based on leverage alone.

To navigate potential choppier waters ahead, it has a strong preference for active management in this space over index strategies, which have greater exposure to larger and potentially more leveraged issuers.

‘Such end-of-cycle dynamics will underscore the need for active management with

extensive experience in navigating significant volatility and re-pricing,’ said Kirkpatrick.

‘In the meantime, however, a slowly growing economy coupled with stable fundamentals for the majority of high yield industries and tight technicals given the relatively light amount of issuance compared to leveraged loans are expected to produce a benign environment for high yield, at least in the short term.’

MATT HARRIS HIGHTOWER ADVISORS HighTower Advisors has been reducing its exposure to US high yield during the second half of 2019.

‘The trifecta of strong performance in the first half of the year, continued deceleration of the US economy and

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FALLEN ANGEL BONDS: RESURRECTING VALUE IN HIGH YIELD In this Q&A, Fran Rodilosso, Head of Fixed Income ETF Portfolio Management at VanEck, discusses what sets fallen angel high yield bonds apart from the broad high yield universe and why investors should be paying attention to this unique segment.

FRAN RODILOSSO, CFA HEAD OF FIXED INCOME ETF PORTFOLIO MANAGEMENT

WHAT ARE FALLEN ANGEL HIGH YIELD BONDS? Fallen angel bonds are part of the overall high yield universe but unique in that they were originally issued with investment grade ratings and later downgraded to non-investment grade, or high yield. This results in differentiating characteristics versus the broader high yield bond market—such as, a higher average credit quality—and the crossover from investment grade to high yield markets is where the value proposition of fallen angels originates. The investor bases for these two markets have distinct objectives, risk constraints and investment policy statements. When a bond is downgraded to high yield, investment grade investors who cannot, or will not, hold a high yield bond must sell it, which can impact its value. The market tends to anticipate rating actions, so bonds are typically sold and prices driven down prior to the downgrade.

Historically, prices have tended to recover fully during the six months, on average, following the downgrade.

This forced selling phenomenon and the higher quality tilt have driven long-term outperformance of

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fallen angels versus the broad high yield market.1 In addition, fallen angels provide differentiated sector exposure versus the broad market. Downgrades are often concentrated in certain sectors, which allows a fallen angel strategy to be overweight oversold sectors where fundamentals have bottomed out, and benefit from a potential recovery. The result has been an average of 250 basis points of outperformance versus the broader U.S. high yield market per year over the past 10 years, including outperformance in 11 of the last 15 calendar years.2 CAN INVESTORS ANTICIPATE FALLEN ANGELS? ARE THERE CONDITIONS TODAY THAT COULD BE INFLUENCING FACTORS? At an individual issuer level, the market does tend to anticipate downgrades, as seen in the bond price prior to downgrade. In general, a bond will be downgraded if a credit rating agency believes the probability of default has increased. Reasons for this may include management decisions around leverage, mergers and acquisitions, macro trends—such as declining industries or industries where competition has cut into margins—or a combination of factors. Following the dramatic decline in oil and commodity prices that began in 2014, we saw a significant number of energy-related fallen angels.

Predicting the exact timing of the next wave of downgrades or the sectors that will be most impacted is challenging. The volume of fallen angels has been quite low in recent years due to a tremendous amount of liquidity in the markets in recent years and the longest economic expansion in U.S. history. When these conditions are no longer present, and when credit tightens, we think that will likely be the catalyst for the next wave of downgrades. Investment grade

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companies with the most leverage and reliance on re-financing will be most vulnerable.

HOW DO FALLEN ANGELS FIT WITHIN A PORTFOLIO GIVEN WHERE WE ARE IN THE MARKET CYCLE? Credit spreads are wider than a year ago, but still tight versus historical averages. Given where we are in the credit cycle, corporate and high yield bond investors are, understandably, a little nervous. But investors still need income, and the challenge is to find it without taking excessive risk in this extremely low interest rate environment. Many investors have strategic, dedicated high yield exposure and are looking for ways to mitigate potential risk in their portfolio without sacrificing carry. We think fallen angels present an attractive solution because they provide many of the qualities that income investors need in a late-cycle market environment: attractive carry, higher quality and a value-oriented approach.

Historically, environments where the amount of fallen angels spikes—typically after the cycle has turned—have been associated with outperformance of fallen angels versus the broad U.S. high yield market.3 The more bonds investors can buy at attractive prices, the more that benefits performance, on average. In addition, higher quality bonds tend to have lower

drawdowns in periods of stress and have historically experienced lower default rates.4 The yield on fallen angels is currently in line or higher than other broad U.S. high yield indices, including those which some of the largest high yield ETFs track, so moving up in credit quality does not mean sacrificing yield.5 HOW CAN INVESTORS ACCESS THE FALLEN ANGEL HIGH YIELD BOND MARKET? Fallen angels comprise only 10% of the broader high yield market and currently total over $100bn in market value.6 We think a rules-based approach, such as the VanEck Vectors® Fallen Angel High Yield Bond ETF (ANGL), can be an efficient way for income investors to access this segment of the market.

Since inception, ANGL has outperformed its Morningstar category average by over 300 basis points, as of 9/30/19, placing it at the top of the category.7 It has also outperformed active high yield bond strategies as measured by the Morningstar High Yield Bond category average over the same time period.8 This is a contrarian strategy that buys bonds that others are selling and goes overweight sectors that have hit rock bottom. We believe, it would take a tremendous amount of conviction for an active manager to apply this strategy with such discipline, particularly in stressed market conditions.

Source: ICE Data Services. Based on the performance of the ICE BofAML US High Yield Index and the ICE BofAML US Fallen Angel High Yield Index from 12/31/2003 to 9/30/2019.

Ibid.

Ibid.

Source: ICE Data Services. Based on the par amount of bonds that have defaulted annually in the ICE BofAML US Fallen Angel Index and the ICE BofAML US High Yield Index from 12/31/2003 to 9/30/2019.

5 Source: ICE Data Services and VanEck. Data as of 9/30/2019.

6 Source: ICE Data Services. Based on the total market value of the ICE BofAML US Fallen Angel Index and the ICE BofAML US High Yield Index. Data as of 9/30/2019.

7 Source: Morningstar. The Morningstar category is US Fund High Yield Bond. For the 5 year period ending 9/30/19, ANGL is ranked #1 out of 527 funds based on total return.

From inception of 5/1/2012, ANGL total return is 8.15% per annum vs the average category total return of 5.03%.

8 Source: Factset. Data as of 9/30/2019.

1 2 3 4

Important Disclosures: Past performance is not a guarantee of future results. Performance current to the most recent month end is available by calling 800.826.2333.

An investment in the VanEck Vectors® Fallen Angel High Yield Bond ETF (ANGL®) may be subject to risk which includes, among others, high yield securities, foreign securities, foreign currency, credit, interest rate, restricted securities, market, operational, call, sampling, basic materials, energy, financial services, telecommunications, index tracking, authorized participant concentration, no guarantee of active trading market, trading issues, passive management, fund shares trading, premium/discount and liquidity of fund shares and concentration risks, all of which may adversely affect the Fund.

ICE Data Indices, LLC and its affiliates (“ICE Data”) indices and related information, the name “ICE Data”, and related trademarks, are intellectual property licensed from ICE Data, and may not be copied, used, or distributed without ICE Data’s prior written approval. The licensee’s products have not been passed on as to their legality or suitability, and are not regulated, issued, endorsed, sold, guaranteed, or promoted by ICE Data. ICE Data MAKES NO WARRANTIES AND BEARS NO LIABILITY WITH RESPECT TO THE INDICES, ANY RELATED INFORMATION, ITS TRADEMARKS, OR THE PRODUCT(S) (INCLUDING WITHOUT LIMITATION, THEIR QUALITY, ACCURACY, SUITABILITY AND/OR COMPLETENESS).

Index returns are not Fund returns and do not reflect any management fees or brokerage expenses. Certain indices may take into account withholding taxes. Investors can not invest directly in the Index. Returns for actual Fund investors may differ from what is shown because of differences in timing, the amount invested and fees and expenses. Index returns assume that dividends have been reinvested.

ICE BofAML US Fallen Angel High Yield Index (H0FA, “Index”), formerly known as BofA Merrill Lynch US Fallen Angel High Yield Index prior to 10/23/2017, is a subset of the ICE BofAML US High Yield Index (H0A0, “Broad Index”), formerly known as BofA Merrill Lynch US High Yield Index prior to 10/23/2017), including securities that were rated investment grade at time of issuance. H0FA is not representative of the entire fallen angel high yield corporate bond market.

Fund shares are not individually redeemable and will be issued and redeemed at their NAV only through certain authorized broker-dealers in large, specified blocks of shares called “creation units” and otherwise can be bought and sold only through exchange trading. Shares may trade at a premium or discount to their NAV in the secondary market. You will incur brokerage expenses when trading Fund shares in the secondary market. Past performance is no guarantee of future results. Returns for actual Fund investments may differ from what is shown because of differences in timing, the amount invested, and fees and expenses.

The “Net Asset Value” (NAV) of a VanEck Vectors Exchange Traded Fund (ETF) is determined at the close of each business day, and represents the dollar value of one share of the fund; it is calculated by taking the total assets of the fund, subtracting total liabilities, and dividing by the total number of shares outstanding. The NAV is not necessarily the same as the ETF’s intraday trading value. VanEck Vectors ETF investors should not expect to buy or sell shares at NAV. Investing involves substantial risk and high volatility, including possible loss of princi pal. Bonds and bond funds will decrease in value as interest rates rise. An investor should consider the investment objective, risks, charges and expenses of the Fund carefully before investing. To obtain a prospectus and summary prospectus, which contains this and other information, call 800.826.2333 or visit vaneck.com. Please read the prospectus and summary prospectus carefully before investing.

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HIGH YIELD

THE HIGH YIELD MARKET IS ALSO LESS LIQUID AND TRANSPARENT THAN THE INVESTMENT GRADE MARKET. THIS LIQUIDITY EBBS AND FLOWS WITH ECONOMIC DATA AND INVESTOR SENTIMENT

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escalation of trade wars all increased our desire to ensure our fixed income allocations provide stability and diversification to a total portfolio,’ said Matt Harris, its head of investment strategy.

At the beginning of the year, a moderate risk client had around 6% of their overall portfolio in US high yield. Since then, HighTower has reduced that allocation to around 2.5%.

Harris believes the vehicle used to access high yield is very important to risk management for investors. The group likes unconstrained credit strategies that have the flexibility to tactically allocate towards or away from high yield. The unconstrained credit strategy it currently uses has recently reduced its allocation to the segment.

‘We see high yield as a market that is still inefficient and, therefore, we prefer active management in high yield,’ said Harris.

‘First, there are structural challenges associated with tracking a high yield index. For example, the high yield index is constructed in a way where the more debt a company has

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issued, the larger they are within the index. This, by default, results in owning a larger share of the more indebted companies within the index.

‘The high yield market is also less liquid and transparent than the investment grade market.

This liquidity ebbs and flows with economic data and investor sentiment, therefore we see benefit in having a manager who can evaluate the market and position liquidity in periods of market stress. Also, a more tactical approach can better take advantage of market aberrations or credit specific events that affect bond prices.’

When searching for high yield managers, HighTower looks for three key criteria. From a fund profile perspective, it favors lower volatility strategies as these allow them to stomach volatility when it arises in high yield.

Secondly, it prefers high yield managers who have the flexibility in their strategy to seek returns in investment grade bonds and bank loans when these parts of the credit market present good opportunities. Lastly, and most importantly, it likes to see a credit team that has invested through multiple credit events and is large enough to have enough research staff to perform thorough research throughout the issue and credit spectrum.

LARRY SWEDROE BUCKINGHAM STRATEGIC WEALTH Buckingham Strategic Wealth does not allocate to the high yield sector – a position that remains unchanged regardless of what is happening in the economy or financial markets.

Larry Swedroe, its director of research, points to three main roles for fixed income in portfolios – safety of principal, reliability of income and portfolio stability to allow investors to take equity risk.

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THE ALMOST PERFECT CORRELATION OF GOVERNMENT BONDS AND INVESTMENT GRADE BONDS IS EVIDENCE THAT INVESTMENT GRADE BONDS CONTAIN ALMOST NO EQUITY COMPONENT

‘The risks of high yield debt make them inappropriate for meeting the first two objectives,’ he said. ‘Unfortunately, while it is true that high yield debt has nonperfect correlation with equities, the correlation may increase at just the wrong time – when the distress risk of equities shows up. A great example is what happened in 2008.’

Swedroe believes the higher yield is insufficient reason to branch out from Treasury bonds and highly-rated corporate debt – the kind of fixed income instruments that the advisory group does recommend.

Swedroe points to Fama and French’s three-factor model to explain as much as 85% of the spread between corporate and Treasury bonds that is not explained by their different

tax treatment and expected default loss.

‘The three factors are the exposure to the risk of the overall stock market, the risk of small versus large companies and the risk of value versus growth companies,’ he said. ‘And the lower the credit rating (and the longer the maturity), the greater the explanatory power of the model,’ he said.

‘Thus, much of the expected return from high yield debt is explained by risk premiums associated with equities, not debt. These risks are systematic risks that cannot be diversified away.’

Swedroe regards high yield bonds as hybrid securities that provide little benefit in terms of portfolio diversification.

‘The almost perfect correlation of government bonds and investment grade bonds is evidence that investment grade bonds contain almost no equity component,’ he said.

‘Since government bonds have no credit risk, the only thing explaining their return is interest rates. Thus, we can also conclude that almost all of the returns of high credit quality fixed income instruments are derived from interest rate risk. This is decidedly not the case for high yield bonds.’

The equity-like risk characteristics of high yield debt pose a problem for asset allocation and building, say, a 60/40 equity/bond portfolio.

‘Since high yield debt is really taking on equity risk, the investor will actually be holding a portfolio that has more equity risk than a 60% equity/40% fixed income portfolio would hold,’ he added.

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HIGH YIELD

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