Will this five star fund continue to thrive after the PM departs?February 4th, 2013 by Marc Prosser
The Fund in question is Delaware High-Yield Opportunities Fund (DHOAX), which received a 5-star rating from Learn Bonds in early December of 2012. While the fund’s performance has been volatile, historically it has outperformed its peers over 1-, 3-, 5- and 10-year time periods. From 2007 until mid-December 2012, Kevin Loome was the fund’s portfolio manager. He was replaced by a quartet of portfolio managers including Thomas Chow, Craig Dembek, Paul Matlack and John McCarthy.
Will this quartet be able to continue to put up great performance numbers? To answer that question, we interviewed Thomas Chow (Tom) and Paul Matlack.
How Experienced Is The New Team?
Before interviewing Tom, we looked up his track record as a portfolio manager. He has managed Delaware Corporate Bond Fund and Delaware Extended Duration Bond Fund since 2007. His performance managing those two funds has been stellar. The Corporate Fund has averaged 10.13% annual total return over the last 5 years. The Extended Duration Fund did even better with a 13.46% average annual performance. There are some differences between these funds and the Delaware High Yield Fund. These funds have much longer durations (more sensitivity to interest rate moves) and hold bonds with higher credit ratings. Tom is experienced and successful managing corporate bond funds, however, time will tell if this experience is directly applicable to managing a fund focused on high-yield segment of the corporate bond market.
Will the new managers make changes Delaware High-Yield Opportunities Fund?
Both Paul and Tom strongly stressed that there would be no changes in the investment style of the Fund. Tom did say however that the Fund has been adapting to changes in market conditions. Major Wall Street bond dealers with which the Fund frequently trades, have grown more conservative than in the past. These dealers are now less likely to position inventory as well as consistently make a market in less liquid deals. As a result, smaller positions may be more appropriate given the market environment but Delaware High-Yield Opportunities Fund will continue to invest in around 200 issuers compared to the US High Yield Bond market, which is composed of approximately 1,000 issuers.
What is the fund’s strategy?
When evaluating a bond, the team looks at the following:
1) Liquidity – What is the company’s cash position? What type of lending facilities does the company have access to?
2) Refinancing Risk – When does the company have debt coming due? What is the risk that the company will have trouble re-financing it?
3) Management – How accurate has management been in predicting future performance? Does management follow through with its announced plans?
4) Business Strength – How much control does the company have over its future?
Using these parameters, Delaware’s team classifies bonds that fit into 4 categories: core holdings, undervalued, upgrade and opportunistic.
Core holdings are bonds that the team believes have the characteristics of consistency (an expectation that there is a low probability of negative surprises) and strong sponsorship (bonds with strong sponsorship are more liquid than similar bonds without it). Risk of a ratings downgrade is expected to be minimal for a core holding. Some of the bonds in this group may be categorized by the rating agencies as very high risk (CCC) because of the leverage (debt relative to the size of the business) that the companies employ. Delaware identifies through its own research core bonds that its analysis indicates are underpriced by the market.
Undervalued bonds trade at higher yields than their ratings peer group based on unfair or misunderstood stigmas. After the beginning of the Greek crisis, there was a major sell-off in corporate bonds in countries like Spain and Italy. Fears of those countries entering a recession or depression caused foreign investors to dump bonds from issuers based in those countries. Delaware thinks that there was little differentiation between good and bad bonds during the sell-off. They used the sell-off to buy bonds at 70 and 80 cents of their face value. As a result, around 20% of Delaware High-Yield Opportunities Fund is invested in non-US opportunities including European names.
The Fund also tries to identify bonds that are upgrade candidates. As bonds have their ratings upgraded by S&P, Moody’s, and Fitch, they tend to have a small positive change in value. Prior to the rating change, as the market’s perception of the bond issuer’s financial condition changes, there tends to be a larger move in the bond’s value. Delaware tries to be one of the first to anticipate the changes in an issuer’s financial condition.
Finally, the opportunistic category can be classified as finding short-term opportunities resulting from the abundance of investable cash chasing after a limited amount of deals in the new issue market or certain sectors within the high-yield market..
Can the fund implement these strategies as effectively as it has in the past?
Tom Chow and Paul Matlack play down the importance of their new roles with the High-Yield Opportunities Fund. They emphasize the importance of Delaware’s research analysts and traders in the Fund’s performance. Twelve of the fourteen analysts who worked with the previous portfolio manager remain at the firm. The message that Delaware portfolio managers are trying to send is simple: the past performance is the result of a team effort and not due to a super-star manager.
Let’s assume that the superior past performance was partially the result of super-star manager. Even if this was the case, it doesn’t mean that Delaware High-Yield Opportunities Fund will not continue to do well. After interviewing 2 of the 4 new managers and examining Tom Chow’s track records, Learn Bonds has a positive outlook on the fund. However, the fund operates in the context of the high-yield bond market. The fund’s future performance will depend both on the portfolio managers and the overall performance of the high yield bond market.