“Success is more a function of consistent common sense than it is of genius.” – An Wang

Our high yield team focuses on the diligent implementation of our disciplined investment process. Our security selection is driven by bottom-up, value-based fundamental research; top down analysis plays a secondary role. However, bottom-up credit work ultimately includes observations and conclusions regarding top-down issues specific to individual credits. Portfolio level risk management involves direct top-down analyses focused on trading liquidity, correlations, concentrations, etc. Our macro observations tend to be uncomplicated, utilitarian, blunt and fallible (of course).

We’ll share a few of the key macro issues that are currently observed & debated among the three co-PM’s of the high yield group. Hopefully, our views will prove to be honest and provocative, at the very least. We’ll move from the broadest of topics to more credit specific views of leveraged credit in general, and our high yield asset class in particular. We cover Central Banks first (with the balance of our macro views below: “Concerns, not Indictments”).

Central Banks

Source: HEDGEYE

Recent sell-side research estimates that major global CBs have expanded their aggregate balance sheets by $15-16 trillion since the 2008 Great Financial Crisis (GFC).

We aren’t inclined to weigh in on the accuracy of sell-side estimates, the net addition to global liquidity or even the wisdom of “the trillions.” We’ll simply share a few thoughts..

A $20tn Stockpile

 

Source: National central banks.

Observations

#1: Absent the CB interventions of the previous decade, the broad spectrum of global financial market asset classes would not have attained their current price levels.

#2: The storyline of “QT” pundits (quantitative tightening) lies somewhere between naive and fanciful. In short, $20 trillion of stimulus injected directly into financial markets will not be methodically withdrawn regardless of the effects on global asset prices (the real “data” in former Fed Chair Yellen’s term “data dependent”).

#3: Mario Draghi’s “Whatever it takes” speech remains our base case expectation for the CBs: “more of the same.”

(Please see “Concerns, Not Indictments” below for the balance of our narrowing focus, macro observations).

 

High Yield Market Commentary

Price volatility returned to the financial markets during the first quarter of 2018. The S&P 500 declined 10% in price in the two weeks between January 26th and February 8th, the first sell-off greater than 5% since June 2016.

The broad high yield market as represented by the ICE BofAML US Constrained High Yield index traded down in concert with stocks, declining 2.4% in price over the two weeks ending February 9th.

The causes of the financial market correction are open to debate. The New Year began with continued weakness in the U.S. dollar to a 3-year low, and a further increase in the 10-year US Treasury to a 4-year high. That seems as good a reason as any other. The ever popular “risk parity” strategy doesn’t like itself when stock and bonds trade down together, but we have no way of knowing if that increased the sharpness of the two week sell-off.

Another interesting fundamental year-to-date has been an accelerating increase in 3-month LIBOR, but the majority of that increase occurred immediately following the low in the S&P 500. The 3-month LIBOR rate began the year at 1.69% and ended the first quarter at 2.31%, +62 bps. The 3-month T-bill increased “just” 36 bps, to 1.73%. Context is usually fun: the low in the 3-month T-bill was -0.025% on October 1, 2015. We still scratch our heads at negative interest rates despite Mario Draghi’s assurances that they make perfect sense.

The first quarter total return of the broad high yield market was -0.91%, with a -2.42% price decline partially offset by 1.51% of income return. The index yield increased +51 bps to 6.35% but the spread-to-worst by only +11 bps to +384, due to a 40 bps increase in the comparable US Treasury rate. In terms of the Index rating tranches, the BB, B & CCC sub-indexes generated total returns of -1.7%, -0.4% & +0.55% respectively. The underperformance of BB credits was largely due to higher Treasury rates given its longer duration and a quarterly income return disadvantage of -60 bps. Relative sector weakness during the quarter can be looked at in two ways. In terms of absolute total return, the Banking, Cable & Restaurant sectors’ total returns of -2.6% each were the worst performers. Factoring in sector weights within the broad index, Cable and Energy accounted for 35% of the market’s decline.

Portfolio Positioning

We always strive to take advantage of the relative value opportunities presented by any noticeable market correction, and the first quarter proved a success on that front. One noticeable theme around the market low was a moderate rotation out of relative safety, and into relative risk in the E&P sector. WTI crude oil also traded down -10.6% during the two week correction, and as of this writing has broken above this year’s January high.

We have seen issuer count increase modestly as a result of select new issues that were attractive based on our investment process, and a few new net secondary additions. Our Broad High Yield composite issuer count increased to 154, above the lower end of our typical issuer count range for the first time in a couple of quarters. However issuer count still reflects the historically narrow opportunity set presented by the current high yield market. The “opportunity set” is the pool of high yield securities that meet both our minimum margin-of-safety requirements, and over-compensate in yield and spread, for our estimates of their individual default risks.

Credit selection drove benchmark outperformance: most noticeable in Broad High Yield given its optimal portfolio is running at a yield and spread somewhat below benchmark.

Composite Performance Summary

Note: Past performance is not indicative of future performance. Performance figures do not reflect the deduction of investment advisory fees. A client’s return will be reduced by the investment fees. If a client placed $100,000 under management and a hypothetical gross return of 10% were achieved, the investment assets before fees would have grown to $259,374 in 10 years. However, if an advisory fee of 1% were charged, investment assets would have grown to $234,573, or an annual compounded rate of 8.9%.

The assets within the Short Duration High Yield Composite and Quality High Yield Composite have been combined to create the FSI Defensive High Yield Composite. The assets within the Select High Yield Composite and the Quality High Yield Composite have been combined to create the Broad High Yield Composite.

Analysis: “Concerns, not Indictments”

Global Debt Levels

By all reports it seems global debt sits at an all-time high. A recent Bloomberg news report cited an estimate of $237 trillion, or 318% of global GDP. Armed with an internet search engine one could conclude that some estimates suggest global debt increased $88 trillion since 2007, versus a $21 trillion increase in GDP. We have no opinion as to even the ballpark accuracy of such figures but “all time high” sounds about right. As does an ever increasing, record high debt resulting in a diminishing increase in global GDP. It seems highly probable that total global debt, and global debt/ GDP are both significantly higher than the pre-GFC levels of 2007.

The Federal Reserve is also in the business of tracking debt levels and we find their tally of “consumer credit outstanding” to be noteworthy. As of February 2018, total U.S. consumer credit outstanding appears to be an all-time record $3.9 trillion; ditto for its subcomponents: Revolving (credit cards) and Non-revolving (primarily auto and student loans). We observe this situation and wonder how much debt represents too much burden on consumers, in general.

Finally, exploding U.S. Federal government deficits & debt is well covered. Obviously, the U.S. has plenty of company with most other countries seemingly in the same situation. Japan is certainly one high profile example, among so many.

 

Observations

#1: In general, the financial markets exhibit impressive complacency regarding the record high level of global debt.

#2: We can defend this complacency primarily in contrast to the debt problems that resulted in the GFC: the “toxic” MBS structured product that triggered the GFC represented a global distribution of a highly leveraged, but U.S. specific housing bubble. The greater financial crisis was the result of undercapitalized banks using extreme leverage; along with many other financial market participants (e.g. hedge funds). By comparison, the record high debt of today is much more widely distributed, and less leveraged (hopefully).

#3: Our concerns regarding current markets largely involves Correlation and Liquidity. The “toxic” MBS structured products pre-GFC have been replaced by a myriad of other “financial innovations” today, e.g. exponential growth of: passive investment strategiesrisk parity strategies, private credit funds, and derivative swaps (assuming zero systemic risk).

Our concern is not an indictment of any of these investment strategies, per se. Our concerns involves two common tendencies in any complacent bull market:

• Correlation, meaning too many investors “betting the same way” and/or relying on back tested models that are not immune to an “off-model” event/trend.

Liquidity, meaning too much money in pursuit of higher returns in over-crowded and/or relatively illiquid asset classes.

We do not pretend to be experts in any investment class except leveraged credit in general, and high yield in particular. As such we will briefly mention our concerns about the “Direct Lending” market, which involves high yield lending.

 

Direct Lending Credit Funds

What do veteran investors of publicly traded corporate securities know about Private Lending? Not enough to be experts – more than enough to observe potential concerns.

We observe too much capital raised relative to the size of the quality opportunity set of the asset class. We suspect that a typical inflection point has passed and newer funds are likely unattractive as excess demand compromises underwriting standards and pricing. Direct Lending also presents a couple of inherent structural disadvantages, through the lens of our high yield investment process.

 

Observations

#1: The mantra of direct lending proponents remains: significant yield premium, secured loans, stronger covenants, shorter average maturities and no mark-to-market “nuisance.”

#2: We see familiar looking bull-market trends in direct lending: increasingly greater amounts of capital raised, a slew of new multi-billion marquee funds and unproven manager entrants. The risk of subpar underwriting and pricing looks real to us.

#3: It is natural for us to wonder about private lending because our high yield investment process begins with a mechanical screen that would immediately eliminate most direct lending from consideration. We typically avoid high yield issuers with less than 150 mm of bonds; not primarily because of trading liquidity concerns, but rather our experience that the issuers tend to be less strategic in their industries; in terms of market share, costs or other sustainable competitive advantage.

#4: The lack of tradable liquidity in the direct lending market would also eliminate one of the critical advantages of our investment process. We are typically light on credit risk when our market corrects from relatively full valuation levels. Our ability to rotate into greater credit risk on market breaks is the opportunity to position for our strongest total return periods.

 

Summary

Simple is Good. We like the outlook for long only high yield. The spread-to-worst of the high yield market, recently ranging between +350 to +400 bps is attractive given our base case outlook for continued low credit default rates.

We employ no leverage and believe inevitable market corrections represent total return opportunities.

The dual focus of our investment process on stringent, minimum margin of safety requirements, and pricing that overcompensates for estimated default risk is, by nature contrarian in implementation. We believe that the successful implementation of our investment process achieves:

• Lower downside volatility than the overall market

• Superior total returns over a full market cycle.

 

Broad High Yield¹

This strategy has the widest high yield market opportunity set. The benchmark is the ICE Bank of America Merrill Lynch US High Yield Constrained Index. The excess return target is 100bps².

Composite Performance

Broad High Yield returned -0.17% for 1Q18, which outperformed the ICE BofA Merrill Lynch US High Yield Constrained Index by 74bps. Since inception on May 1st, 2017, FSI Broad High Yield has outperformed its Index by 143bps³.

¹ The assets within the FSI Select High Yield Composite and the FSI Quality High Yield Composite have been combined to create the FSI Broad High Yield Composite.

² Return target is solely intended to express an objective or target for a return on your investment and represents a forward-looking statement. It does not represent and should not be construed as a guarantee, promise or assurance of a specific return on your investment. Actual returns may differ materially from the performance objective, and there are no guarantees that you will achieve such returns. Please refer to the disclaimer page for additional information.

³ Past performance is not an indication of future performance.

 

Positive Contributors (top three):

Rite Aid (RAD): Provided outsized returns during the quarter after announcing in February plans to merge with Albertsons in a combined $24bn transaction. Rite Aid will continue with its previously announced store divestment and debt pay-down plan which underpinned our original investment thesis. Under the terms of the merger we believe our bonds benefit from a 101 change of control put covenant. Furthermore, given other restricted covenants we see additional price appreciation in our bonds and expect them to be refinanced at their call price by late 2018 or early 2019.

Frontier Communications (FTR): Strong performance in Frontier bonds was driven by a number of factors including signs of stabilization in 4Q17 operating results, a much welcomed elimination of its common stock dividend and most notably capital market activities. We have long expected Frontier would seek to exchange near-term maturities for secured securities. During the quarter, 1st lien lenders agreed to create junior lien capacity which enabled the company to execute a cash paid premium tender offer which included our notes and was financed with a new 2nd lien bond issuance. All of which helped clear the company’s maturity runway conceivably through 2021.

Meredith (MDP): Meredith Corp issued bonds during the quarter to fund its acquisition of Time Inc. The bonds were issued at a concession and rallied in the weeks following issuance, driven by investor appetite for the credit, which benefits from relatively moderate pro forma leverage and strong synergy potential.

 

Negative Contributors (bottom three):

Cincinnati Bell (CBB): Underperformed after releasing lackluster 4Q17 earnings which were further complicated by its mid-quarter closing on its OnX acquisition and also included a change in a portion of its GAAP revenue accounting methodology. The company is yet to close (2H18 expected) on the Hawaiian Telecom merger which is further clouding projections and estimated pro forma leverage estimates. In light of acquisition integration risks and relative pricing our Cincinnati Bell position was meaningfully reduced in the quarter. We remain constructive on the company’s fiber centric broadband-cable and telecom services strategies and will closely monitor its bonds for better relative and absolute value opportunities.

Simmons Foods (SIMFOO): Weak performance during the quarter was driven by continued concern over the company’s ability to execute its extensive capital spending program amidst near term inflationary pressures. As well, the pricing of a higher quality competitor’s bond issue at relatively attractive levels and the market’s aversion to duration risk weighed on bond levels.

Altice International (ALTICE): Altice International bonds underperformed during the quarter after reporting somewhat disappointing 4Q17 results. The quarter was also complicated by the company’s announcement in early January to spin-off its US subsidiary and in the process use cash proceeds to pay down debt at its Holdco unit and move some assets among its varied subsidiaries. All in all we believe management remains very focused on de-leveraging as it is widely thought to be the desired means to improve the company’s share price. Cable multiples also contracted during the period which further weighed on the company’s bonds. We remain optimistic the company is close to announcing further sizeable non-core asset sales that have been earmarked to pay down debt.

Note: Securities discussed are the largest positive and negative contributors for the specific sectors.

 

Select High Yield

This is a more concentrated strategy in high conviction ideas. The benchmark is the ICE Bank of America Merrill Lynch US High Yield Constrained Index. The excess return target is 150bps⁴.

Composite Performance

Select High Yield returned 0.06% for 1Q18 which outperformed the ICE BofA Merrill Lynch US High Yield Constrained Index by 97bps. Since inception on May 1st, 2017, FSI Select High Yield has outperformed its Index by 164bps⁵.

⁴ Return target is solely intended to express an objective or target for a return on your investment and represents a forward-looking statement. It does not represent and should not be construed as a guarantee, promise or assurance of a specific return on your investment. Actual returns may differ materially from the performance objective, and there are no guarantees that you will achieve such returns. Please refer to the disclaimer page for additional information.

⁵ Past performance is not an indication of future performance.

 

Positive Contributors (top three):

Frontier Communications (FTR): Strong performance in Frontier bonds was driven by a number of factors including signs of stabilization in 4Q17 operating results, a much welcomed elimination of its common stock dividend and most notably capital market activities. We have long expected Frontier would seek to exchange near-term maturities for secured securities. During the quarter, 1st lien lenders agreed to create junior lien capacity which enabled the company to execute a cash paid premium tender offer which included our notes and was financed with a new 2nd lien bond issuance. All of which helped clear the company’s maturity runway conceivably through 2021.

Rite Aid (RAD): Provided outsized returns during the quarter after announcing in February plans to merge with Albertsons in a combined $24bn transaction. Rite Aid will continue with its previously announced store divestment and debt pay-down plan which underpinned our original investment thesis. Under the terms of the merger we believe our bonds benefit from a 101 change of control put covenant. Furthermore, given other restricted covenants we see additional price appreciation in our bonds and expect them to be refinanced at their call price by late 2018 or early 2019.

Endo International (ENDP): Provided solid performance in the period under heightened volatility. The name has been heavily out of favor and was particularly depressed in value at year-end having become a poster child for the media and state driven opioid litigation. Our holdings in the company’s shortest maturity benefited in the market’s beginning year rally and we used the opportunity to divest our unsecured bond position at attractive levels. Although the company continues to deliver solid operating results and boasts attractive FCF characteristics, great uncertainty looms over litigation exposures and durability questions surrounding a few core pharmaceutical products. As such we have repositioned our holdings into the company’s first lien bonds.

 

Negative Contributors (bottom three):

Cincinnati Bell (CBB): Underperformed after releasing lackluster 4Q17 earnings which were further complicated by its mid-quarter closing on its OnX acquisition and also included a change in a portion of its GAAP revenue accounting methodology. The company is yet to close (2H18 expected) on the Hawaiian Telecom merger which is further clouding projections and estimated pro forma leverage estimates. In light of acquisition integration risks and relative pricing our Cincinnati Bell position was meaningfully reduced in the quarter. We remain constructive on the company’s fiber centric broadband-cable and telecom services strategies and will closely monitor its bonds for better relative and absolute value opportunities.

Simmons Foods (SIMFOO): Weak performance during the quarter was driven by continued concern over the company’s ability to execute its extensive capital spending program amidst near term inflationary pressures. As well, the pricing of a higher quality competitor’s bond issue at relatively attractive levels and the market’s aversion to duration risk weighed on bond levels.

Valeant Pharmaceuticals (VRXCN): Valeant’s 1Q18 under performance was in part due to its strong performance realized in 4Q17. Having the benefit of hindsight, it appears the valuation in both the company’s stock and bonds became overly optimistic. 2018 earnings expectations needed to come down and management re-set more appropriate targets on its 4Q17 earnings call held in late February. The company’s operating turnaround remains on track and near-term maturities have been refinanced allowing for an adequate runway. However, the much anticipated growth phase remains a 2019-2020 “show me” event. While we expect the company to execute on new product initiatives we also anticipate up and down challenges and opportunities will follow.

Note: Securities discussed are the largest positive and negative contributors for the specific sectors.

 

Quality High Yield

This strategy is focused on the higher quality segment of the high yield market. The benchmark is the ICE Bank of America Merrill Lynch US High Yield BB-B Constrained Index. The excess return target is 100bps⁶.

Composite Performance

Quality High Yield returned -0.27% for 1Q18 which outperformed the ICE BofA Merrill Lynch BB-B US High Yield Constrained Index by 84bps. Since inception on May 1st, 2017, FSI Quality High Yield has outperformed its Index by 170bps⁷.

⁶ Return target is solely intended to express an objective or target for a return on your investment and represents a forward-looking statement. It does not represent and should not be construed as a guarantee, promise or assurance of a specific return on your investment. Actual returns may differ materially from the performance objective, and there are no guarantees that you will achieve such returns. Please refer to the disclaimer page for additional information.

⁷ Past performance is not an indication of future performance.

 

Positive Contributors (top three):

Rite Aid (RAD): Provided outsized returns during the quarter after announcing in February plans to merge with Albertsons in a combined $24bn transaction. Rite Aid will continue with its previously announced store divestment and debt pay-down plan which underpinned our original investment thesis. Under the terms of the merger we believe our bonds benefit from a 101 change of control put covenant. Furthermore, given other restricted covenants we see additional price appreciation in our bonds and expect them to be refinanced at their call price by late 2018 or early 2019.

Frontier Communications (FTR): Strong performance in Frontier bonds was driven by a number of factors including signs of stabilization in 4Q17 operating results, a much welcomed elimination of its common stock dividend and most notably capital market activities. We have long expected Frontier would seek to exchange near-term maturities for secured securities. During the quarter, 1st lien lenders agreed to create junior lien capacity which enabled the company to execute a cash paid premium tender offer which included our notes and was financed with a new 2nd lien bond issuance. All of which helped clear the company’s maturity runway conceivably through 2021.

Meredith (MDP): Meredith Corp issued bonds during the quarter to fund its acquisition of Time Inc. The bonds were issued at a concession and rallied in the weeks following issuance, driven by investor appetite for the credit, which benefits from relatively moderate pro forma leverage and strong synergy potential.

 

Negative Contributors (bottom three):

Cincinnati Bell (CBB): Underperformed after releasing lackluster 4Q17 earnings which were further complicated by its mid-quarter closing on its OnX acquisition and also included a change in a portion of its GAAP revenue accounting methodology. The company is yet to close (2H18 expected) on the Hawaiian Telecom merger which is further clouding projections and estimated pro forma leverage estimates. In light of acquisition integration risks and relative pricing our Cincinnati Bell position was meaningfully reduced in the quarter. We remain constructive on the company’s fiber centric broadband-cable and telecom services strategies and will closely monitor its bonds for better relative and absolute value opportunities.

Simmons Foods (SIMFOO): Weak performance during the quarter was driven by continued concern over the company’s ability to execute its extensive capital spending program amidst near term inflationary pressures. As well, the pricing of a higher quality competitor’s bond issue at relatively attractive levels and the market’s aversion to duration risk weighed on bond levels.

Altice International (ALTICE): Altice International (e.g. Altice Financing SA and Altice Finco SA) bonds underperformed during the quarter driven by deteriorating investor sentiment regarding the cable sector, as highlighted by declines in the equities of ATCNA (Altice International’s parent) and cable peers. Headlines regarding potential asset sales benefited Altice International bonds differentially; the bonds with the tightest covenants outperformed the rest of the structure, while those with the weakest covenants underperformed.

Note: Securities discussed are the largest positive and negative contributors for the specific sectors.

 

Short Duration High Yield

This is a more defensive strategy with limited interest rate exposure. The benchmark is the ICE Bank of America Merrill Lynch 1-5 Year BB-B Cash Pay High Yield Constrained Index. The excess return target is 75bps⁸.

 

Composite Performance

Short Duration High Yield returned 0.39% for 1Q18 which outperformed the ICE BofA Merrill Lynch 1-5 yr BB-B US Cash Pay High Yield Constrained Index by 24bps. Since inception on May 1st, 2017, FSI Short Duration High Yield has outperformed its Index by 43bps⁹.

⁸ Return target is solely intended to express an objective or target for a return on your investment and represents a forward-looking statement. It does not represent and should not be construed as a guarantee, promise or assurance of a specific return on your investment. Actual returns may differ materially from the performance objective, and there are no guarantees that you will achieve such returns. Please refer to the disclaimer page for additional information.

⁹ Past performance is not an indication of future performance.

 

Positive Contributors (top three):

Rite Aid (RAD): Provided outsized returns during the quarter after announcing in February plans to merge with Albertsons in a combined $24bn transaction. Rite Aid will continue with its previously announced store divestment and debt pay-down plan which underpinned our original investment thesis. Under the terms of the merger we believe our bonds benefit from a 101 change of control put covenant. Furthermore, given other restricted covenants we see additional price appreciation in our bonds and expect them to be refinanced at their call price by late 2018 or early 2019.

Frontier Communications (FTR): Strong performance in Frontier bonds was driven by a number of factors including signs of stabilization in 4Q17 operating results, a much welcomed elimination of its common stock dividend and most notably capital market activities. We have long expected Frontier would seek to exchange near-term maturities for secured securities. During the quarter, 1st lien lenders agreed to create junior lien capacity which enabled the company to execute a cash paid premium tender offer which included our notes and was financed with a new 2nd lien bond issuance. All of which helped clear the company’s maturity runway conceivably through 2021.

A Schulman (SHLM): A Schulman bonds outperformed during the quarter, driven by the company’s announcement of an agreement to be purchased by LyondellBasell. LyondellBasell indicated that it plans to redeem the A Schulman bonds following deal closing and the bonds are now trading to their first call date.

 

Negative Contributors (bottom three):

Standard Industries (BMCAUS): Standard Industries weak performance during the quarter was driven by disappointing earnings results on the back of inflationary pressures, and by the longer duration of this position relative to the rest of the portfolio.

CommScope (COMM): CommScope underperformed in the period as 1Q18 guidance was modestly below expectations. Although, the market largely overlooked the Q1 figure. More importantly, FY 2018 guidance was in line and implies EBITDA growth at a high-single-digit-percentage rate vs 2017. The decline in CommScope bonds is thought to be primarily duration related. Rising interest rates in the quarter coupled with modest spread expansion reduced the likelihood that the bonds will be refinanced at the earliest call prior to maturity.

Dish Corp (DISH):Dish bonds underperformed during the quarter driven by deteriorating investor sentiment regarding the satellite cable sector and weak 4Q17 results in late February. Dish 4Q17 results missed street expectations on both the top-line and bottom-line, driven primarily by lower than expected ARPU.

Note: Securities discussed are the largest positive and negative contributors for the specific sectors.

 

Defensive High Yield¹⁰

This is a defensive strategy that focuses on the higher quality segment of the high yield market with more limited interest rate exposure. The benchmark is the ICE Bank of America Merrill Lynch BB-B US High Yield Constrained Index. The excess return target is 100bps¹¹.

 

Composite Performance

Defensive High Yield returned -0.11% for 1Q18 which outperformed the ICE BofA Merrill Lynch BB-B US High Yield Constrained Index by 100bps. Since inception on May 1st, 2017, FSI Defensive High Yield has outperformed its Index by 160bps¹².

¹⁰ The assets within the FSI Short Duration High Yield Composite and FSI Quality High Yield Composite have been combined to create the FSI Defensive High Yield Composite.

¹¹ Return target is solely intended to express an objective or target for a return on your investment and represents a forward-looking statement. It does not represent and should not be construed as a guarantee, promise or assurance of a specific return on your investment. Actual returns may differ materially from the performance objective, and there are no guarantees that you will achieve such returns. Please refer to the disclaimer page for additional information.

¹² Past performance is not an indication of future performance.

 

Positive Contributors (top three):

Rite Aid (RAD): Provided outsized returns during the quarter after announcing in February plans to merge with Albertsons in a combined $24bn transaction. Rite Aid will continue with its previously announced store divestment and debt pay-down plan which underpinned our original investment thesis. Under the terms of the merger we believe our bonds benefit from a 101 change of control put covenant. Furthermore, given other restricted covenants we see additional price appreciation in our bonds and expect them to be refinanced at their call price by late 2018 or early 2019.

Frontier Communications (FTR): Strong performance in Frontier bonds was driven by a number of factors including signs of stabilization in 4Q17 operating results, a much welcomed elimination of its common stock dividend and most notably capital market activities. We have long expected Frontier would seek to exchange near-term maturities for secured securities. During the quarter, 1st lien lenders agreed to create junior lien capacity which enabled the company to execute a cash paid premium tender offer which included our notes and was financed with a new 2nd lien bond issuance. All of which helped clear the company’s maturity runway conceivably through 2021.

Meredith (MDP): Meredith Corp issued bonds during the quarter to fund its acquisition of Time Inc. The bonds were issued at a concession and rallied in the weeks following issuance, driven by investor appetite for the credit, which benefits from relatively moderate pro forma leverage and strong synergy potential.

 

Negative Contributors (bottom three):

Cincinnati Bell (CBB): Underperformed after releasing lackluster 4Q17 earnings which were further complicated by its mid-quarter closing on its OnX acquisition and also included a change in a portion of its GAAP revenue accounting methodology. The company is yet to close (2H18 expected) on the Hawaiian Telecom merger which is further clouding projections and estimated pro forma leverage estimates. In light of acquisition integration risks and relative pricing our Cincinnati Bell position was meaningfully reduced in the quarter. We remain constructive on the company’s fiber centric broadband-cable and telecom services strategies and will closely monitor its bonds for better relative and absolute value opportunities.

Simmons Foods (SIMFOO): Weak performance during the quarter was driven by continued concern over the company’s ability to execute its extensive capital spending program amidst near term inflationary pressures. As well, the pricing of a higher quality competitor’s bond issue at relatively attractive levels and the market’s aversion to duration risk weighed on bond levels.

Altice International (ALTICE): Altice International (e.g. Altice Financing SA and Altice Finco SA) bonds underperformed during the quarter driven by deteriorating investor sentiment regarding cable sector, as highlighted by declines in the equities of ATCNA (Altice International’s parent) and cable peers. Headlines regarding potential asset sales benefited Altice International bonds differentially; the bonds with the tightest covenants outperformed the rest of the structure, while those with the weakest covenants underperformed.

Note: Securities discussed are the largest positive and negative contributors for the specific sectors.

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Disclaimer

This material is solely for the attention of institutional, professional, qualified or sophisticated investors and distributors who qualify as qualified purchasers under the Investment Company Act of 1940, as accredited investors under Rule 501 of SEC Regulation D under the US Securities Act of 1933, and as qualified eligible persons as defined under CFTC Regulation 4.7. It is not to be distributed to the general public, private customers or retail investors in any jurisdiction whatsoever.

The information included within this presentation and any supplemental documentation is for informational and illustrative purposes, is furnished on a confidential basis, is intended only for the use of the authorized recipient, and should not be copied, reproduced or redistributed without the prior written consent of First State Investments (US) LLC (“FSI US”) or any of its affiliates (together with FSI US, “First State Investments”). This document is not an offer for sale of funds to US persons (as such term is used in Regulation S promulgated under the 1933 Act).

Any investment with First State Investments should form part of a diversified portfolio and be considered a long term investment. Prospective investors should be aware that returns over the short term may not match potential long term returns. Investors should always seek independent financial advice before making any investment decision. The value of an investment and any income from it may go down as well as up. Currency movements may affect both the income received and the capital value of investments in overseas markets. Where a fund invests in fixed income securities changes in interest rates will affect the value of any securities held. If rates go up, the value of fixed income securities fall; if rates go down, the value of fixed income securities rise.

PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE RESULTS.

All reasonable care has been taken in relation to the preparation and collation of this presentation. The information is taken from sources which are believed to be accurate but First State Investments and its directors, officers and employees accept no liability of any kind to any person who relies on the information contained in it. No representation or warranty, express or implied is made as to the truth, fairness, accuracy, or completeness of the information herein. Data, opinions, and estimates may be changed without notice. The copyright of this presentation and any documents supplied with it and the information therein is vested in First State Investments.

Any discussion of a performance objective is solely intended to express an objective or target for a return on your investment and represents a forward-looking statement. It does not represent and should not be construed as a guarantee, promise or assurance of a specific return on your investment. Actual returns may differ materially from the performance objective, and there are no guarantees that you will achieve such returns. We cannot and do not warrant the accuracy or the validity of the performance objective and are not liable if actual returns differ in any way from such performance objective.

Certain statements, estimates, and projections in this document may be forward-looking statements. These forward-looking statements are based upon First State Investments’ current assumptions and beliefs, in light of currently available information, but involve known and unknown risks and uncertainties. Actual actions or results may differ materially from those discussed. Readers are cautioned not to place undue reliance on these forward-looking statements. There is no certainty that current conditions will last, and First State Investments undertakes no obligation to publicly update any forward-looking statement.

The comparative benchmarks or indices referred to herein are for illustrative and comparison purposes only, may not be available for direct investment, are unmanaged, assume reinvestment of income, and have limitations when used for comparison or other purposes because they may have volatility, credit, or other material characteristics (such as number and types of securities) that are different from the funds managed by FSI US.

Reference to the names of each company mentioned in this communication is merely for explaining the investment strategy, and should not be construed as investment advice or investment recommendation of those companies. Companies mentioned herein may or may not form part of the holdings of FSI.

For more information please visit www.firststateinvestments.com/us. Telephone calls with First State Investments may be recorded.

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