Finding value in high-yield bonds and preferred stocks
With interest rates on a historic rise since early 2022, Eric Mollenhauer, co-manager of Fidelity Advisor® Floating Rate High Income Fund, is finding value beyond the fund's core leveraged-loan holdings to capitalize on other attractively valued securities in the fixed-income market.
"Earlier in 2023, we added positions in high-yield corporate bonds and preferred stocks because there was compelling value in these categories," says Mollenhauer, who co-manages the fund along with Kevin Nielsen and Chandler Perine.
The fund is a diversified leveraged-loan strategy that focuses primarily on floating-rate, secured loans made to non-investment-grade companies.
The rationale for casting a wider investment net to supplement the fund's core allocation to floating-rate leveraged bank loans, Mollenhauer says, is to take advantage of attractive credits that have been punished more than is warranted by the issuers' business fundamentals.
As of July 31, about 6% of the portfolio was invested in high-yield bonds and preferred stocks, up from 4% at the beginning of 2023.
"Rising interest rates pushed the prices of many high-yield bonds significantly lower," Mollenhauer explains. "As a result, we were able to purchase some credits at a sizable discount to par (face) value."
The co-managers also have added fixed- and floating-rate preferred shares issued by investment-grade companies. "On the preferred side, we are finding some opportunities in BBB-preferred stock that have higher floating spreads than comparatively or even lower-rated loans," says Mollenhauer.
Within the fund's core allocation, the co-managers target loans from companies that are industry leaders with strong collateral. They look for businesses that can generate strong cash flow through a market cycle, and they're not afraid to buy loans that have been sold due to disappointing earnings.
"Because we take a long-term view with the fund's core holdings, we look to buy loans that we believe can survive a temporary setback," says Mollenhauer.
While the managers expect the default rate to tick up over the foreseeable future, they think the spread portion of the coupon provides substantial protection for long-term investors if the default rate increases, according to Mollenhauer. And historically, the senior position that loans have in a company's capital structure have provided higher recovery rates versus more junior debt.
"We plan to maintain our emphasis on issuers that we believe have favorable near-term business fundamentals, positive and sustainable free-cash-flow trends, and a strong management team," he concludes.
For specific fund information such as standard performance and holdings, please go to the "Funds Managed" link on this page.
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