Caroline Brown, Morley Fund Management
Caroline Brown, head of credit analysis at Morley Fund Management, and her team of four analysts support a stable of almost 100 fixed-income funds. This massive fixed-income business – totaling £52 bn ($92 bn) – penetrates just about every financial crevice: life, general insurance, institutional, retail and pooled pension funds, not to mention much of Norwich Union’s high-profile retail business.
Based in London, Brown draws on deep experience. She joined Morley only in January this year from Credit Suisse Asset Management, having notched up almost a decade in credit research with Goldman Sachs.
Morley’s fixed-income business is, naturally enough, heavily tilted toward cash flow. ‘We look at the general ability to service debt,’ says Brown. ‘If there’s a will to maximize cash flow, then a company may be looking at improving cost control.’ Good management of working capital, a disciplined capex program and a well thought-out acquisition program are also likely to catch her eye.
Brown meets management teams regularly via roadshows, though private discussions tend to bear more fruit. ‘[Private discussions] can be a better way to judge not only what is being said, but also the force behind it,’ she notes. ‘You catch a lot of nuances. It also makes the questioning process a lot easier. You don’t just sit there and listen to what’s being told to you. However, roadshows are helpful in getting a sense of what the group mood is, and issues others have raised, as well as to get a sense of how widely held your own concerns are.’
But fixed-income valuations can be tricky, Brown says. ‘’There are more variables to consider in determining whether a company’s bonds – which, unlike equities, may be issued in various currencies and in different maturities – are appropriately priced,’ she points out. ‘There’s no one right answer.’ Nevertheless, comparing like-with-like can get you around this to an extent, she believes.
Off-balance sheet intangibles get a forensic going-over. ‘Two companies might look similar in terms of their reported financials, but one might have higher pension liabilities or exposure to litigation, which you have to factor in,’ says Brown. This Yale graduate says by now she’s pretty immune to annual report gloss and sales smarm. ‘Clear financials are what I’m interested in, and attention paid to items that concern debt-holders,’ she states. ‘Most professional investors cut to the chase – we like to see consistent reporting. For example, if a company breaks down its net debt and interest expense in its annual accounts, then we like to see that done every quarter. We like everything to be as detailed and as consistent as possible.’
Andrew Crawford, Threadneedle
If there’s any truth in the rumor that fixed-income practitioners follow a dark, hermetic science, then Andrew Crawford, a director in the eight-strong investment-grade credit team at Threadneedle in London, is quick to scotch it. ‘This conception that bonds and fixed-income are complicated, that the only thing we’re interested in is financial ratios from accounts… Actually, we’re buying a security, expecting a return and, ultimately, our money back,’ he says. Just like equity managers, in fact. ‘My upside,’ he goes on, ‘is that the bond does what it says on the tin, and that I get my annual coupons. The downside is that I lose my capital.’
Crawford, who deals mainly in investment-grade and BBB- (or better) bonds, acknowledges that valuations can involve some tricky reckoning. A credit-based financial and forecasting model helps his team slice through the numbers. But, fundamentally, the business is about credit quality. ‘Then it’s a question of comparing your opinion with the credit rating agencies’ opinions and with the market’s opinion, and making a comparison with bonds of a similar credit quality and a similar maturity to assess whether you’re getting incremental yield,’ he explains.
However, the impact of an S&P or Moody’s verdict is never far away. ‘The market places so much emphasis on those,’ Crawford says. ‘Even if you disagree with them you still have to understand how they came to a decision.’ He reckons his team disagrees with agency verdicts between 20 percent and 40 percent of the time. ‘If a company makes a large acquisition,’ he continues, ‘we have to rapidly find out what impact it will have on the firm’s credit quality. But the agencies often wait to talk to the management of a company until the deal is completed, which could be months into the future.’
IR presentations tend to be of limited value for Crawford – if he has a question he’s more likely to pick up the phone. ‘We like to think we know companies well enough to not have to go through all that nonsense,’ he explains. He also feels a group conference can mean the risk of revealing your hand.
One thing Crawford finds intensely frustrating is how little effort is put into seeing the bond side. ‘Very few firms do a good job here,’ he complains. ‘Daily Mail and General Trust Group recently said it wanted to see our equity and bond teams together. The treasury department at National Grid Transco also makes good contact. But that’s its treasury deciding to do this, rather than any IR initiative. It’s frustrating that you see a CFO when a company wants money, but you seem to be forgotten when it doesn’t.’
Dan Sperrazza, Northern Trust Global Investments
Blame it on Reg FD. Since the introduction of this SEC clean-up rule, Dan Sperrazza just doesn’t get IR folk coming through his Chicago office anymore. Or not in the same numbers, anyway. ‘Face-to-face meetings have seriously declined in frequency since [Reg FD],’ he notes. ‘But we’ve seen a dramatic increase in the number of electronic presentations, roadshows and webcasts.’
Despite this shift away from one-on-one meetings, Sperrazza, director of fixed-income research at Northern Trust Global Investments, says hands-on management contact remains a priority. ‘Most of the flow of information focuses on the equity market,’ he says, ‘so we need to talk to management to assess the fortunes of shareholders and bondholders to see if they are in alignment. Are they willing to buy back shares to maintain share price, for example?’
Although fixed-income professionals do share some common ground with equity teams, the two departments travel on diverging paths. ‘What’s important to income investors,’ says Sperrazza, ‘is a subtle but important distinction [from equities] – a shift away from the minor variations in quarterly earnings and a focus on longer-term results. I’m less interested if a company takes a charge against earnings to do some restructuring. What I care about is the longer-term implications for cash flow.’
He’s also concerned about the long-term prospect of a falling dollar. In the short term, more unevenness in exchange rates is inevitable, he says. ‘Over the longer term it plays into valuations of participants in a global industry, like the auto industry,’ he explains. ‘Market share trends haven’t changed much so far, but over time I would question the ability of European manufacturers to continue to make money in very competitive US markets.’
Some companies, however, may be able to deploy strategies to take the edge off a shrinking greenback. ‘Maybe they have natural hedges, or global operations where they can shift production or sourcing – you can factor all these in,’ Sperrazza notes.
However, being able to factor good corporate governance into the books is something else. Much of Sperrazza’s focus is on underlying accounting and oversight. Quality and integrity, he hopes, stem from this. ‘If the people at the top are crooked, the books are most likely a little aggressive,’ he says.
Alas, fixed-income investors, many of whom prize ten-year to 30-year rate stability above all else, haven’t been immune from recent corporate fraud scandals. Sperrazza points out that some of the biggest losses in the fixed-income world occurred in the Ahold and Parmalat debacles: ugly surprises that bear out Sperrazza’s plea for better communication. ‘IROs need to understand our need for transparency and consistency,’ he comments. ‘We want negative trends disclosed early – and often. We don’t want something under-represented until it’s too big a problem to avoid.’
Kevin Akioka, Payden High Income Fund
How do you get the plain, rock-bottom truth from a company you’re about to lend a lot of money to? Put it on the spot, suggests Kevin Akioka, manager of the Payden & Rygel High-Yield Bond Fund, and invite it to a little equity and fixed-income analyst get-together. ‘You accomplish two different funding points that way,’ Akioka says, ‘and you get a much more robust meeting with management, as well as a story with a lot less spin.’
Hopefully, you also get a story with a strong credit position. To maintain his fund’s high-income focus, Akioka concentrates on higher-quality, below-investment BB to CCC grade companies. ‘I want to see managers with good industry experience who operationally understand their business,’ he explains. ‘I don’t want so-called financial managers who are more interested in getting a quick pop in earnings without thinking about the long term. People who are good operationally tend to take a long-term view. You are always looking for strong credit quality, because, in effect, you are lending this company money for ten years – and you want it back!’
Especially if you are committing between $15 mn and $20 mn, Akioka’s average position. In total, he has about $2.5 bn in high-yield fixed income under management, though Payden & Rygel manages around $51 bn overall.
Akioka’s nine-strong credit analyst team gets out and presses the flesh regularly, physically meeting management, in most cases, before committing to a deal. ‘More often than not our analyst will know the CFO or IRO,’ he says. ‘Talking to the IR professional to facilitate more information flow or senior contact is usual.’ Conversation devolves rapidly to funding strategies and the profit picture. Business position, particularly in the crushingly competitive retail sector, for example, is critical. ‘You need economies of scale and buying power,’ notes Akioka, ‘but it’s hard to get good information sometimes. You’re relying on management, vendors and suppliers. These people know first if a company gets into trouble over late payments.’
Crunching-in expected cash flow is a prerogative. ‘In any given quarter of a year you’re going to have non-recurring items,’ Akioka points out, ‘so the analyst’s job is to look at that and come out with a reasonable figure to pay down debt.’
The beaten-down dollar has yet to disturb Akioka’s sleep. Most US high-yield firms receive much of their revenue in US dollars, so there’s little currency risk to worry about for the moment, he says. ‘But the long-term implications may be felt next year,’ he adds. ‘When you think of companies with non-dollar revenues, the currency hedging has been pretty good. Currency risk is less of a worry today than it was five years go. Alternatively, you can always issue in sterling.’
Keeping up with company news has been made vastly easier by the internet. The 10Qs and 10Ks can now be raked through as soon as the SEC issues them, says Akioka. ‘What I also like is when companies in the US put up analyst presentations they have done at a conference or big shareholder meeting,’ he explains. ‘That’s a nice step forward.’
Corporate governance does matter to this fixed-income fund manager, though he struggles to establish just how on- or off-base companies are with their corporate governance programs. ‘So much goes on behind closed doors that what people are really thinking is difficult to get a handle on,’ he says. ‘If a company is going to do something fraudulent, it will lie about it anyway.’
