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First Eagle High Yield Fund Mid-Year Commentary
Posted by: Holly LaFon (IP Logged)
Date: September 4, 2013 11:21AM
The financial markets were buffeted by shifting yield expectations brought upon by May commentary from Fed Chairman Ben Bernanke indicating that further accommodation will be data dependent. While the message was unsurprising, the timing caught most by surprise and resulted in the 10-year treasury yield increasing 86 basis points.1
Volatility also increased across the board as investors digested this "new'" piece of information. High yield wasn't spared in this broad sell-off as interest rate risk (through declining yields) had crept into the valuation discussion.
Despite this upheaval, we feel the outlook for the high yield market remains constructive. Moreover, in contrast to this recent yield induced sell-off, performance of the high yield market has historically been less correlated with increases in interest rates than other fixed income asset classes, such as investment grade and Treasuries. Generally, high yield, as an asset class, is largely driven by the fundamental credit quality of sub-investment grade borrowers. Accordingly, spreads and prices are ultimately determined by the level and volatility of corporate cash flows as well as the willingness and ability of borrowers to repay their obligations. In our view, these fundamental attributes remain sound as of June 30, 2013.
As many companies continued to focus on managing their balance sheets, default rates remained relatively low. According to Standard & Poor's (S&P), as of June 30, 2013, the default rate for the last twelve months was 2.5%.2
In addition to the low default rate, the percentage of new issue proceeds used for refinancing is another variable which has historically indicated the relative strength of the high yield market. Year to date as of 6/30/2013, the percentage of new issue proceeds used for refinancing was 63% compared to 33% and 43% in 2007 and 2008, respectively.3
While high yield returns may have been negatively impacted in the near term, the correction we saw in the second quarter of the year produced valuations we feel are more attractive.
Although we are constructive on the high yield market, no investment is without risks. We are cognizant of the gradual deterioration of covenant structures and the resurgence of interest in collateralized loan obligations (CLOs). We feel the CLO demand in 2004, 2005 and 2006 led to a decline in underwriting standards, which eventually spilled over into the high yield market. So far we have not seen the rise in investments in CLOs lead to a steep decline in underwriting standards. Also, given the accommodative credit markets, it was not surprising to see a revival in mergers and acquisitions activity. There were several large deals announced during the first six months of 2013, including Berkshire Hathaway's purchase of H.J. Heinz for $27 billion, and the $24 billion buyout of Dell Computer. Despite these high profile leveraged buyouts (LBOs), strategic acquisition activity has dominated the M&A landscape as companies seek ways to increase productivity through cost and capacity rationalization. Historically, this type of acquisition activity has generally been neutral to positive for credit quality. In contrast, financially motivated transactions have tended to increase the debt burden of corporations.
Our overweighting in Consumer Cyclical and underweighting in Technology and Financials positively contributed to the portfolio's performance over the six-month period. In contrast, we were negatively impacted by our weighting in Energy. The shorter duration of the Fund and our bank loan exposure helped to reduce the impact of the sudden increase in yields. We've increased our bank loan exposure from 12% at the end 2012 to approximately 22% as of June 30, 2013
The top five contributors to performance for the first six months were Advanced Micro Devices, Inc. (AMD) 6.0% 05/01/15 (+0.18%), The Sheridan Group, Inc. 12.5% 04/15/14 (+0.12%), Offshore Group Investments Ltd. 7.5% 11/01/19 (+0.12%), Marfrig Overseas Ltd. 9.5% 05/04/20 (+0.11%), and Kemet Corporation (KEM) 10.5% 05/01/18 (+0.10%).
The largest detractors from performance for the six-month period were OGX Petroleo E Gas Participacoes S.A. 8.5% 06/01/18 (-0.49%), Mood Media Corporation 9.25% 10/15/20 (-0.16%), OGX Austria GmbH 8.375% 04/01/22 (-0.13%), SandRidge Energy, Inc. 7.5% 02/15/23 (-0.08%) and Frontier Communications Corporation 8.5% 04/15/20 (-0.05%).
We remain focused on credit fundamentals, but will continue to be diligent about monitoring the Fund's exposure to rising interest rates. Overall, we continue to favor short duration, single B-rated issues, which accounted for about 61% of the Fund in the second quarter compared with approximately 42%4
in the Barclays Capital U.S. Corporate High Yield Index. But as mentioned, we feel valuations are more attractive given the recent correction and we will make gradual shifts in strategy as opportunities present themselves. We appreciate your confidence and thank you for your support.
First Eagle Investment Management, LLC
The performance data quoted herein represents past performance and does not guarantee future results. Market volatility can dramatically impact the fund's short-term performance. Current performance may be lower or higher than figures shown. The investment return and principal value will fluctuate so that an investor's shares, when redeemed, may be worth more or less than their original cost. Past performance data through the most recent month end is available at firsteaglefunds.com or by calling 800.334.2143.
Performance figures reflect contractualwaivers and/or expense limitations,withoutwhich totalreturns may have been lower.
Class I Shares require $1MMminimum investment and are offeredwithout sales charge. Performance information is forClass I Shareswithoutthe effect of sales charges and assumes all distributions have been reinvested and if a sales chargewas included valueswould be lower.Had fees not beenwaived and/or expenses reimbursed,the performancewould have been lower.ClassAandCshares have maximum sales charge of4.50%and 1.00%respectively, and 12b-1fees, which reduce performance.The Fund commenced operations in its presentform onDecember 30, 2011, and is successorto another mutualfund pursuantto a reorganizationDecember 30, 2011. Information priortoDecember 30, 2011is forthis predecessorfund. Immediately afterthe reorganization, changes in net asset value oftheClass I shareswere partially impacted by differences in howthe Fund and the predecessorfund price portfolio securities.
*These are the actualfund operating expenses priorto the application offeewaivers and/or expense reimbursements.TheAdviser has contractually agreed to limit operating expenses ofthe Fund to an annualrate of0.80%forI shares,1.25%forAShares, and 2.00%forCShares,with gross operating expenses of1.03%,1.27%, and 2.02%,respectively.This limitation excludes certain expenses as described in the Fees and Expenses section ofthe prospectus.This limitationwill continue until December 31, 2013.The expense limitation may be terminated by theAdviserin future years.
The Fund invests in high yield securities (commonly known as "junk bonds") which are generally considered speculative because they may be subject to greater levels of interest rate, credit (including issuer default) and liquidity risk than investment grade securities and may be subject to greater volatility. The Fund invests in high yield securities that are non-investment grade. High yield, lower rated securities involve greater price volatility and present greater risks than high rated fixed income securities. High yield securities are rated lower than investment-grade securities because there is a greater possibility that the issuer may be unable to make interest and principal payments on those securities. All investments involve the risk of loss.
Bank loans are often less liquid than other types of debt instruments. There is no assurance that the liquidation of any collateral from a secured bank loan would satisfy the borrower's obligation, or that such collateral could be liquidated.
Funds that invest in bonds are subject to interest-rate risk and can lose principal value when interest rates rise. Bonds are also subject to credit risk, in which the bond issuer may fail to pay interest and principal in a timely manner, or that negative perception of the issuer's ability to make such payments may cause the price of that bond to decline. There are risks associated with investing in funds that invest in securities of foreign countries, such as erratic market conditions, economic and political instability and fluctuations in currency exchange rates. Funds whose investments are concentrated in a specific industry or sector may be subject to a higher degree of risk than funds whose investments are diversified and may not be suitable for all investors.
The fund's investment strategies may result in high turnover rates. This may increase the Fund's brokerage commission costs, which would reduce performance. Rapid portfolio turnover also exposes shareholders to a higher current realization of short-term gains, which could cause you to pay higher taxes.
The holdings mentioned herein representthe following percentage ofthe total net assets ofthe First EagleHighYield Fund as ofJune 30, 2013:AdvancedMicro Devices, Inc.6.0%05/01/15 1.50%,The SheridanGroup, Inc.12.5%04/15/140.75%,OffshoreGroup Investments Ltd. 7.5%11/01/191.18%,MarfrigOverseas Ltd. 9.5%05/04/200.00%,KemetCorporation 10.5%05/01/181.35%,OGXPetroleo EGas Participacoes S.A.8.5%06/01/180.34%,OGXAustriaGmbH8.375% 04/01/220.09%,MoodMediaCorporation9.25%10/15/201.09%, SandRidge Energy, Inc. 7.5%02/15/23 1.05%and FrontierCommunicationsCorporation8.5% 04/15/201.30%.The portfolio is actively managed and holdings can change at any time.Current and future portfolio holdings are subjectto risk.
The commentary represents the opinion oftheHighYieldTeam PortfolioManagers as ofJune 30, 2012 and is subjectto change based on market and other conditions.The opinions expressed are not necessarily those ofthe firm.These materials are provided forinformational purpose only.These opinions are notintended to be a forecast offuture events, a guarantee offuture results, orinvestment advice.Any statistics contained herein have been obtained from sources believed to be reliable, butthe accuracy ofthis information cannot be guaranteed.The views expressed herein may change at any time subsequentto the date ofissue hereof.The information provided is notto be construed as a recommendation or an offerto buy or sell orthe solicitation of an offerto buy or sell any fund or security.
Acreditrating as represented here, is an assessment provided by a nationally recognized statisticalrating organization (NRSRO) or creditworthiness of an issuer with respectto debt obligations, including specific securities, money marketinstruments, or other bonds.Ratings are measured on a scale that generally ranges from AAA(highest)toD(lowest);ratings are subjectto changewithout notice.NotRated (NR)indicates thatthe debtorwas notrated and should not be interpreted as indicating lowquality. For more information on the Standard&Poor's rating methodology, please visit standardandpoors.com and select"UnderstandingRatings" underRatingResources.The BarclaysCapitalU.S.CorporateHighYield Bond Index is comprised of fixed-rate, publicly issued, non-investment grade debt, is unmanaged,with dividends reinvested, and is not available for purchase.The index includes both corporate and non-corporate sectors.The corporate sectors are Industrial,Utility, and Finance,which include bothU.S. and non-U.S. corporations.The index is presented here for comparison purposes only.One cannotinvest directly in an index.
Investors should consider investment objectives, risks, charges and expenses carefully before investing. The prospectus and summary prospectus contain this and other information about the Funds and may be obtained by asking your financial adviser, visiting our website at firsteaglefunds.com or calling us at 800.334.2143. Please read our prospectus carefully before investing. Investments are not FDIC insured or bank guaranteed, and may lose value.
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