For financial professionals in Uruguay

Finding value in each other: active collaboration in equity and bond analysis

Seth Meyer, CFA

Seth Meyer, CFA

Head of Fixed Income Strategy | Portfolio Manager


Brent Olson

Brent Olson

Portfolio Manager


Nick Schommer, CFA

Nick Schommer, CFA

Portfolio Manager


Mar 12, 2021

Seth Meyer and Brent Olson, high yield bond Portfolio Managers, and Nick Schommer, US equity Portfolio Manager, discuss the benefits of collaboration in their equity and bond analysis.

  Key takeaways

  • When investing across a full market cycle, analysis of a firm's entire capital structure could be critical to identifying companies with strong business models and sustainable growth opportunities.
  • One aspect of active management that is rarely discussed – and which can be extremely valuable in fundamental research and analysis – is collaboration between a firm’s corporate bond and equity teams.
  • Amid the disrupted environment of the past year, we’ve found this collaboration has been particularly helpful in assessing specific investments and themes and identifying certain troubled areas of the market.

 

After a year of unprecedented disruption, we have seen both equity and corporate credit index levels surpass what many investors would have thought possible nearly a year ago, during the COVID-19 correction. In such an environment, and with the trajectory of the global pandemic still unknown, analysing a firm's entire capital structure could be critical to identifying companies with strong business models and sustainable growth opportunities.

Enter active management. Much is made about the potential strength of active management when valuations may not entirely reflect fundamentals. But one aspect of active management that is rarely discussed – and which can be extremely valuable for this fundamental research and analysis process – is collaboration between a firm’s corporate bond and equity teams.

We recently explored how this collaborative process works at Janus Henderson. Speaking with Seth Meyer and Brent Olson, high yield Portfolio Managers, and Nick Schommer, US equity Portfolio Manager, we found there are many more ways in which managers provide insights to each other than we had imagined. We also learned that what it all boils down to is something everyone would agree is essential: teamwork.

There are equities and bonds, but just one company

Janus HendersonAs Janus Henderson’s corporate research is grounded in bottom-up fundamental analysis, it stands to reason that there is some overlap in the research done by our stock and bond analysts.

Brent: A company typically decides to finance its operations and future growth with a mix of capital: debt (bonds) and equity (stock or shares). Fixed income analysts tend to focus on the appeal of the company’s bonds while equity analysts study the value of its equities. We may focus on different pieces of the company’s financial story, but at the end of the day, we are looking at the same overall company.

While different focuses may lead to different opportunities, sometimes an opportunity passes from one market (such as bonds) to another (such as equities). As Seth explained:

Seth: It’s not uncommon for research done on the fixed income side to eventually evolve into an opportunity in the company’s equity, and vice versa. For instance, bond analysts may be quicker to recognise the impact of a potential debt restructuring. If that happens, a company’s bonds may rally first, but then the equity may subsequently climb as investors weigh the benefits of decreased leverage, better liquidity and an improved credit profile.

So, high yield bond analysts may be able to not only identify an opportunity, but also know when to pass it on to the equity team. Nick elaborated:

Nick: Getting an idea handed off from the high-yield bond team can be a relatively unique opportunity for equity managers. I generally see this when a company’s financial position improves as it deleverages. When a company gets to about a three times debt-to-EBITDA1 ratio, equity investors may begin to see real returns in the form of share buybacks, for example, and may gain more confidence in that company’s ability to invest for future growth.

1EBITDA = earnings before interest, tax, depreciation and amortisation.

But such a handoff can, and does, go both ways.

Nick: On the flip side, we may see a company re-leverage, in order to fund mergers and acquisitions, for instance. In a case where we own that specific share, we can use the insight we have built in making the equity investment – like our relationship with the company’s management team – and share that knowledge with the fixed income analysts. This may be particularly useful if the company’s bond credit rating is in flux as a result of any added debt from an acquisition.

Sometimes, the reason an investment idea can be passed between equity and bond investors is not only because they are segregated by convention, but also because different kinds of investors look for different opportunities:

Nick: With a more highly levered business, we tend to see a greater proportion of hedge fund investors on the equity side. They often have shorter investment time frames and are more comfortable with the additional volatility (and return potential) that high leverage entails. But as a company deleverages and strengthens its balance sheet, more cash can be given to shareholders, and a new base of equity investors may begin to look at the company. If you can get there earlier, you have an advantage: you can potentially arbitrage investor bases’ different appetites for leverage and risk. If we can be told by the fixed income team the leverage may be coming down, we may have an advantage.

The value of differing perspectives

Lenses
While Nick, Seth and Brent were quick to poke fun at each other, they all agreed that – regardless of the opportunity – just looking at the same company or industry from their respective viewpoints added tangible value to the other’s understanding of the opportunity and the ability to find a way to express it:

Nick: In general, equity investors spend more of their time looking at a company’s income statement, while fixed income investors spend more on the balance sheet and cash flow statements. In the case of one company, I was able to understand the liquidity profile better after talking with Brent and Seth, and I saw that they could refinance bonds that would mature in the near term, so I had a ton of confidence in the company’s liquidity profile. It gave me confidence that although the company may have a difficult period, it could get a credit rating upgrade and be a good longer-term investment.

Brent: Good ideas come from the high yield research team to the equity team for two primary reasons. First, we are monitoring trends and progression – both positive and negative – on a company’s balance sheet and we tend to recognise them before the equity market does because it is less focused in that area. Second, it often happens that we have a longer history with a particular company’s management team because they came to us first for financing.

And, predictably, good ideas come the other way too:

Brent: On the other hand, there are specific sectors and industries for which our equity team has deep knowledge that is not as readily available on the fixed income side. We have seen this, for example, in large pharmaceutical companies, which do not have a significant presence in the high yield market. Nick and others on the equity team can serve as a tremendous resource with their in-depth coverage of those areas of the market.

Nick: Kind of you to say so, Brent. And, he is right. In the health care sector, where science is incredibly important, our equity team includes three PhDs. Their insight is invaluable in helping us understand the complexities of various medical devices and drugs. Whereas the fixed income team may own a biotechnology company’s bonds or a convertible bond issued by a large pharmaceutical firm with leverage, I often view myself as a liaison to help them understand the research being done on the equity side.

Seth: I’m enrolling in a PhD. programme. As soon as I finish these jalapeño Cheetos.

Nick: What is it with you and jalapeño Cheetos?

Seth: That is information I am not sharing.

The value of sharing thematic Ideas

Sometimes sharing general thoughts on the economy or social changes can evoke ideas that resonate with a colleague from another department. It turns out that Seth, Nick and Brent are sharing as much – if not more – of their ideas or concerns about various investment ‘themes’ as they are about specific companies. Whether it is the changing role of energy in the US or the impact of COVID-19 on society, these are collaborative explorations:

Nick: Certain segments of the energy sector have been unattractive for some time, in our view, because we believe we are undergoing a generational transformation in how we consume power – away from fossil fuels and toward an increasingly electrical grid-based economy. Through sharing these general ideas with the fixed income guys, we have built our knowledge base and our understanding of specific companies’ balance sheets that they are more focused on. The result is that we have not only identified certain troubled areas (thanks guys) but have also been able to discuss the investment potential in this theme. This type of collaboration proved to be particularly useful during the March 2020 downturn.

At the beginning of the pandemic, we believed that a health solution could enable a return to normal and reopening of the economy. We identified segments we believed could benefit as the economic recovery broadens, like leisure travel and regional gaming. Working with the fixed income team, we sought to better understand changes to company business models and differences in pre- and post-COVID financials to home in on several names.

Seth: It helped us both. Sometimes I had an idea and because of Nick’s knowledge, I was able to flesh it out and find a way to express it in the high yield market, and vice versa. Another example, which may be as boring as it sounds, is aluminium cans. Aluminium is an area that we all believe has long-term secular tailwinds, such as the decline in the use of plastics for environmental reasons, working in its favour. But how to express it? Brent?

Brent: Yeah, I cover several high yield companies in the aluminium space that, although they do not have publicly traded equity, provide us with some data points that are impactful to similar companies that are publicly traded and that have equities. Many of the suppliers for aluminium products, like electric vehicle parts or metal packaging, are high yield companies. They may or may not have equity outstanding, but they dominate a significant part of the aluminium market and benefit from these long-term secular themes we are talking about – the transition to electric vehicles and a decline in the use of plastics. This theme prompted us to come together to share our insights.

Nick: I think the point is that it is iterative. Because I think we arrived at many of these ideas together. The more we talk, the more we understand why the other team owns the companies they do and you start to get more comfortable about asking yourself: ‘why limit ourselves in the way we research companies?’ So, I think that is the process – very iterative, very collaborative.

Value of Team WorkThe value of teamwork

After listening to these portfolio managers from such different markets talk about the value they provide each other, we had to ask: Why don’t more firms do this kind of collaboration?

Nick: They should, but I’m glad they don’t! In many firms, I don’t think the fixed income credit team is working with the equity team quite like we do. I have a great relationship with these guys and am, annoyingly, always picking their brains. But I do help them, too. For example, there is one sector I’ve told them not to own, and when they have listened to me it has really worked out.

Seth: It’s true, and we talk almost every day. I’m not sure there is an independent thought. We will have different discussions within our respective teams, for sure, as we manage different portfolios and different risks, but we’re walking to get coffee together all the time. A lot can be said on a coffee run.

Nick: True. But – even though I say it all the time – for the record: I am better at stealing their great ideas than they are at stealing mine.

Notes
Credit rating: a rating assigned to a borrower, based on their creditworthiness, and assigned by credit rating agencies. The rating is usually given by credit rating agencies, such as S&P Global Ratings or Fitch, which use standardised scores such as ‘AAA’ (a high credit rating) or ‘CCC’ (a low credit rating).
Financial statements: provide information about the business activities and the financial performance of a company. The three main components are the balance sheet (assets, liabilities, and stockholders' equity); the income statement (revenues and expenses) and the cash flow statement (how well a company generates cash to pay its debt, fund its operations and investments).
Leverage: an interchangeable term for gearing or the level of debt within a company: the ratio of a company's loan capital (debt) to the value of its ordinary shares (equity); it can also be expressed in other ways such as net debt as a multiple of earnings. A highly levered business is one with a higher proportion of debt. Deleveraging is the act of reducing debt levels.
Liquidity profile: the ease with which an individual a company can meet their financial obligations with the liquid assets available to them—the ability to pay off debts as they come due.
Volatility: the rate and extent at which the price of a portfolio, security or index, moves up and down.

These are the views of the author at the time of publication and may differ from the views of other individuals/teams at Janus Henderson Investors. Any securities, funds, sectors and indices mentioned within this article do not constitute or form part of any offer or solicitation to buy or sell them.

 

Past performance does not predict future returns. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested.

 

The information in this article does not qualify as an investment recommendation.

 

Marketing Communication.

 

Glossary

 

 

 

Important information

Please read the following important information regarding funds related to this article.

Janus Henderson Capital Funds Plc is a UCITS established under Irish law, with segregated liability between funds. Investors are warned that they should only make their investments based on the most recent Prospectus which contains information about fees, expenses and risks, which is available from all distributors and paying/facilities agents, it should be read carefully. This is a marketing communication. Please refer to the prospectus of the UCITS and to the KIID before making any final investment decisions. The rate of return may vary and the principal value of an investment will fluctuate due to market and foreign exchange movements. Shares, if redeemed, may be worth more or less than their original cost. This is not a solicitation for the sale of shares and nothing herein is intended to amount to investment advice. Janus Henderson Investors Europe S.A. may decide to terminate the marketing arrangements of this Collective Investment Scheme in accordance with the appropriate regulation.
    Specific risks
  • An issuer of a bond (or money market instrument) may become unable or unwilling to pay interest or repay capital to the Fund. If this happens or the market perceives this may happen, the value of the bond will fall.
  • When interest rates rise (or fall), the prices of different securities will be affected differently. In particular, bond values generally fall when interest rates rise. This risk is generally greater the longer the maturity of a bond investment.
  • The Fund invests in high yield (non-investment grade) bonds and while these generally offer higher rates of interest than investment grade bonds, they are more speculative and more sensitive to adverse changes in market conditions.
  • If a Fund has a high exposure to a particular country or geographical region it carries a higher level of risk than a Fund which is more broadly diversified.
  • The Fund may use derivatives towards the aim of achieving its investment objective. This can result in 'leverage', which can magnify an investment outcome and gains or losses to the Fund may be greater than the cost of the derivative. Derivatives also introduce other risks, in particular, that a derivative counterparty may not meet its contractual obligations.
  • When the Fund, or a hedged share/unit class, seeks to mitigate exchange rate movements of a currency relative to the base currency, the hedging strategy itself may create a positive or negative impact to the value of the Fund due to differences in short-term interest rates between the currencies.
  • Securities within the Fund could become hard to value or to sell at a desired time and price, especially in extreme market conditions when asset prices may be falling, increasing the risk of investment losses.
  • The Fund may incur a higher level of transaction costs as a result of investing in less actively traded or less developed markets compared to a fund that invests in more active/developed markets. These transaction costs are in addition to the Fund's Ongoing Charges.
  • Some or all of the ongoing charges may be taken from capital, which may erode capital or reduce potential for capital growth.
  • The Fund may invest in contingent convertible bonds (CoCos), which can fall sharply in value if the financial strength of an issuer weakens and a predetermined trigger event causes the bonds to be converted into shares of the issuer or to be partly or wholly written off.
  • The Fund could lose money if a counterparty with which the Fund trades becomes unwilling or unable to meet its obligations, or as a result of failure or delay in operational processes or the failure of a third party provider.
  • In addition to income, this share class may distribute realised and unrealised capital gains and original capital invested. Fees, charges and expenses are also deducted from capital. Both factors may result in capital erosion and reduced potential for capital growth. Investors should also note that distributions of this nature may be treated (and taxable) as income depending on local tax legislation.
The Janus Henderson Horizon Fund (the “Fund”) is a Luxembourg SICAV incorporated on 30 May 1985, managed by Janus Henderson Investors Europe S.A. Janus Henderson Investors Europe S.A. may decide to terminate the marketing arrangements of this Collective Investment Scheme in accordance with the appropriate regulation. This is a marketing communication. Please refer to the prospectus of the UCITS and to the KIID before making any final investment decisions.
    Specific risks
  • An issuer of a bond (or money market instrument) may become unable or unwilling to pay interest or repay capital to the Fund. If this happens or the market perceives this may happen, the value of the bond will fall. High yielding (non-investment grade) bonds are more speculative and more sensitive to adverse changes in market conditions.
  • When interest rates rise (or fall), the prices of different securities will be affected differently. In particular, bond values generally fall when interest rates rise. This risk is generally greater the longer the maturity of a bond investment.
  • Callable debt securities, such as some asset-backed or mortgage-backed securities (ABS/MBS), give issuers the right to repay capital before the maturity date or to extend the maturity. Issuers may exercise these rights when favourable to them and as a result the value of the fund may be impacted.
  • Emerging markets expose the Fund to higher volatility and greater risk of loss than developed markets; they are susceptible to adverse political and economic events, and may be less well regulated with less robust custody and settlement procedures.
  • The Fund may use derivatives towards the aim of achieving its investment objective. This can result in 'leverage', which can magnify an investment outcome and gains or losses to the Fund may be greater than the cost of the derivative. Derivatives also introduce other risks, in particular, that a derivative counterparty may not meet its contractual obligations.
  • When the Fund, or a hedged share/unit class, seeks to mitigate exchange rate movements of a currency relative to the base currency, the hedging strategy itself may create a positive or negative impact to the value of the Fund due to differences in short-term interest rates between the currencies.
  • Securities within the Fund could become hard to value or to sell at a desired time and price, especially in extreme market conditions when asset prices may be falling, increasing the risk of investment losses.
  • The Fund may incur a higher level of transaction costs as a result of investing in less actively traded or less developed markets compared to a fund that invests in more active/developed markets. These transaction costs are in addition to the Fund's Ongoing Charges.
  • Some or all of the ongoing charges may be taken from capital, which may erode capital or reduce potential for capital growth.
  • The Fund may invest in contingent convertible bonds (CoCos), which can fall sharply in value if the financial strength of an issuer weakens and a predetermined trigger event causes the bonds to be converted into shares of the issuer or to be partly or wholly written off.
  • The Fund could lose money if a counterparty with which the Fund trades becomes unwilling or unable to meet its obligations, or as a result of failure or delay in operational processes or the failure of a third party provider.
  • In addition to income, this share class may distribute realised and unrealised capital gains and original capital invested. Fees, charges and expenses are also deducted from capital. Both factors may result in capital erosion and reduced potential for capital growth. Investors should also note that distributions of this nature may be treated (and taxable) as income depending on local tax legislation.
Janus Henderson Capital Funds Plc is a UCITS established under Irish law, with segregated liability between funds. Investors are warned that they should only make their investments based on the most recent Prospectus which contains information about fees, expenses and risks, which is available from all distributors and paying/facilities agents, it should be read carefully. This is a marketing communication. Please refer to the prospectus of the UCITS and to the KIID before making any final investment decisions. The rate of return may vary and the principal value of an investment will fluctuate due to market and foreign exchange movements. Shares, if redeemed, may be worth more or less than their original cost. This is not a solicitation for the sale of shares and nothing herein is intended to amount to investment advice. Janus Henderson Investors Europe S.A. may decide to terminate the marketing arrangements of this Collective Investment Scheme in accordance with the appropriate regulation.
    Specific risks
  • An issuer of a bond (or money market instrument) may become unable or unwilling to pay interest or repay capital to the Fund. If this happens or the market perceives this may happen, the value of the bond will fall.
  • When interest rates rise (or fall), the prices of different securities will be affected differently. In particular, bond values generally fall when interest rates rise. This risk is generally greater the longer the maturity of a bond investment.
  • The Fund invests in high yield (non-investment grade) bonds and while these generally offer higher rates of interest than investment grade bonds, they are more speculative and more sensitive to adverse changes in market conditions.
  • Callable debt securities, such as some asset-backed or mortgage-backed securities (ABS/MBS), give issuers the right to repay capital before the maturity date or to extend the maturity. Issuers may exercise these rights when favourable to them and as a result the value of the fund may be impacted.
  • If a Fund has a high exposure to a particular country or geographical region it carries a higher level of risk than a Fund which is more broadly diversified.
  • The Fund may use derivatives towards the aim of achieving its investment objective. This can result in 'leverage', which can magnify an investment outcome and gains or losses to the Fund may be greater than the cost of the derivative. Derivatives also introduce other risks, in particular, that a derivative counterparty may not meet its contractual obligations.
  • When the Fund, or a hedged share/unit class, seeks to mitigate exchange rate movements of a currency relative to the base currency, the hedging strategy itself may create a positive or negative impact to the value of the Fund due to differences in short-term interest rates between the currencies.
  • Securities within the Fund could become hard to value or to sell at a desired time and price, especially in extreme market conditions when asset prices may be falling, increasing the risk of investment losses.
  • The Fund may incur a higher level of transaction costs as a result of investing in less actively traded or less developed markets compared to a fund that invests in more active/developed markets. These transaction costs are in addition to the Fund's Ongoing Charges.
  • Some or all of the ongoing charges may be taken from capital, which may erode capital or reduce potential for capital growth.
  • The Fund could lose money if a counterparty with which the Fund trades becomes unwilling or unable to meet its obligations, or as a result of failure or delay in operational processes or the failure of a third party provider.
  • In addition to income, this share class may distribute realised and unrealised capital gains and original capital invested. Fees, charges and expenses are also deducted from capital. Both factors may result in capital erosion and reduced potential for capital growth. Investors should also note that distributions of this nature may be treated (and taxable) as income depending on local tax legislation.
  • The Fund invests in Asset-Backed Securities (ABS) and other forms of securitised investments, which may be subject to greater credit/default, liquidity, interest rate and prepayment and extension risks, compared to other investments such as government or corporate issued bonds and this may negatively impact the realised return on investment in the securities.
Janus Henderson Capital Funds Plc is a UCITS established under Irish law, with segregated liability between funds. Investors are warned that they should only make their investments based on the most recent Prospectus which contains information about fees, expenses and risks, which is available from all distributors and paying/facilities agents, it should be read carefully. This is a marketing communication. Please refer to the prospectus of the UCITS and to the KIID before making any final investment decisions. The rate of return may vary and the principal value of an investment will fluctuate due to market and foreign exchange movements. Shares, if redeemed, may be worth more or less than their original cost. This is not a solicitation for the sale of shares and nothing herein is intended to amount to investment advice. Janus Henderson Investors Europe S.A. may decide to terminate the marketing arrangements of this Collective Investment Scheme in accordance with the appropriate regulation.
    Specific risks
  • Shares/Units can lose value rapidly, and typically involve higher risks than bonds or money market instruments. The value of your investment may fall as a result.
  • Shares of small and mid-size companies can be more volatile than shares of larger companies, and at times it may be difficult to value or to sell shares at desired times and prices, increasing the risk of losses.
  • If a Fund has a high exposure to a particular country or geographical region it carries a higher level of risk than a Fund which is more broadly diversified.
  • This Fund may have a particularly concentrated portfolio relative to its investment universe or other funds in its sector. An adverse event impacting even a small number of holdings could create significant volatility or losses for the Fund.
  • The Fund may use derivatives towards the aim of achieving its investment objective. This can result in 'leverage', which can magnify an investment outcome and gains or losses to the Fund may be greater than the cost of the derivative. Derivatives also introduce other risks, in particular, that a derivative counterparty may not meet its contractual obligations.
  • If the Fund holds assets in currencies other than the base currency of the Fund or you invest in a share/unit class of a different currency to the Fund (unless 'hedged'), the value of your investment may be impacted by changes in exchange rates.
  • When the Fund, or a hedged share/unit class, seeks to mitigate exchange rate movements of a currency relative to the base currency, the hedging strategy itself may create a positive or negative impact to the value of the Fund due to differences in short-term interest rates between the currencies.
  • Securities within the Fund could become hard to value or to sell at a desired time and price, especially in extreme market conditions when asset prices may be falling, increasing the risk of investment losses.
  • The Fund could lose money if a counterparty with which the Fund trades becomes unwilling or unable to meet its obligations, or as a result of failure or delay in operational processes or the failure of a third party provider.
Janus Henderson Capital Funds Plc is a UCITS established under Irish law, with segregated liability between funds. Investors are warned that they should only make their investments based on the most recent Prospectus which contains information about fees, expenses and risks, which is available from all distributors and paying/facilities agents, it should be read carefully. This is a marketing communication. Please refer to the prospectus of the UCITS and to the KIID before making any final investment decisions. The rate of return may vary and the principal value of an investment will fluctuate due to market and foreign exchange movements. Shares, if redeemed, may be worth more or less than their original cost. This is not a solicitation for the sale of shares and nothing herein is intended to amount to investment advice. Janus Henderson Investors Europe S.A. may decide to terminate the marketing arrangements of this Collective Investment Scheme in accordance with the appropriate regulation.
    Specific risks
  • Shares/Units can lose value rapidly, and typically involve higher risks than bonds or money market instruments. The value of your investment may fall as a result.
  • Shares of small and mid-size companies can be more volatile than shares of larger companies, and at times it may be difficult to value or to sell shares at desired times and prices, increasing the risk of losses.
  • If a Fund has a high exposure to a particular country or geographical region it carries a higher level of risk than a Fund which is more broadly diversified.
  • This Fund may have a particularly concentrated portfolio relative to its investment universe or other funds in its sector. An adverse event impacting even a small number of holdings could create significant volatility or losses for the Fund.
  • The Fund may use derivatives towards the aim of achieving its investment objective. This can result in 'leverage', which can magnify an investment outcome and gains or losses to the Fund may be greater than the cost of the derivative. Derivatives also introduce other risks, in particular, that a derivative counterparty may not meet its contractual obligations.
  • If the Fund holds assets in currencies other than the base currency of the Fund or you invest in a share/unit class of a different currency to the Fund (unless 'hedged'), the value of your investment may be impacted by changes in exchange rates.
  • When the Fund, or a hedged share/unit class, seeks to mitigate exchange rate movements of a currency relative to the base currency, the hedging strategy itself may create a positive or negative impact to the value of the Fund due to differences in short-term interest rates between the currencies.
  • Securities within the Fund could become hard to value or to sell at a desired time and price, especially in extreme market conditions when asset prices may be falling, increasing the risk of investment losses.
  • The Fund could lose money if a counterparty with which the Fund trades becomes unwilling or unable to meet its obligations, or as a result of failure or delay in operational processes or the failure of a third party provider.