AAM Newsletter: Winter 2014
March 31, 2015
By John L. Schaefer, CFA
2014 is off to a fast start at AAM. We are carefully monitoring corporate earnings for signs of any potential deterioration in the credit markets. As Reed will discuss below, we believe that the markets will be choppy in 2014 as the economy continues to gain its footing. In this unpredictable environment, we continue to believe that careful credit selection and monitoring will drive success for insurers.
In this issue of AAM’s newsletter, some of the items to note include an update on the state of the High Yield and Bank Loan markets, a spotlight on Tyra Lydon who recently celebrated 30 years with AAM, and a busy quarter in AAM’s community impact in the Chicago area.
Stay warm, and as always, we thank our clients for putting their trust in AAM.
By Reed J. Nuttall, CFA
Chief Investment Officer
The markets have exhibited some volatility this year with major stock indices falling across the globe by 5-10% during January. Ten-year Treasury yields also fell by over 40 basis points as the stress in China and within some emerging economies seemed ready to bubble to the surface. In the U.S., the economic growth seemed anemic at best, with a much worse employment picture and uncertainty over the cause of the weakness (weather or a true slowdown.) Throughout February the markets have improved. Globally, U.S. and European equities have moved back to around flat on the year and interest rates are rising again. This volatility in January and the rebound in February fit with our scenario for the remainder of the year. AAM expects that because of significant leverage across the globe facilitated by easy money policies in the U.S., Japan, and Europe any piece of bad news will cause significant selling as the fast money moves out of the markets and back into government securities. We think that the slow and steady pace of growth among the G-7 economies will provide some stabilization to the volatility in the emerging market sector.
Corporate bonds have continued to perform well and credit spreads have tightened slightly
In this environment, investment grade (IG) fixed income securities have performed very well. The leading sector within the IG market has been tax-exempt municipals as the selling out of mutual funds seen in 2013 has been replaced by buying. We have started reducing our positions in this sector to take advantage of the significant outperformance and to prepare for calendar related underperformance that occurs around tax season. Corporate bonds have continued to perform well and credit spreads have tightened slightly versus Treasury securities year to date. We do not expect to earn much more than the credit spread during 2014, but at current levels we have a favorable opinion of the sector for the remainder of the year. We expect underperformance in the MBS sector as the Fed reduces purchases in this sector from the current $30 billion per month to zero by year end. Our outlook for Treasury securities is negative, as we expect a further steepening of the yield curve in preparation for the Fed to begin discussing the merits of their 0.00% to 0.25% funds target late in 2014. We do not expect the Funds rate to be adjusted upward until well into 2015.
Muzinich & Co. High Yield 2014 Outlook
Early into the New Year, investors are closely following developments at the Federal Reserve as Janet Yellen was confirmed as the next Chair. While the consensus view is that the yield curve will steepen, we take a more nuanced view – believing that the 0 to 5-year portion of the curve will likely remain steep, but that the 5 to 10-year differential, despite tapering, may compress from its current levels. Spreads should tighten, which could offset a rise in Treasuries. The period of experimentation of Central Bank bond buying is coming to an end. It remains to be seen what the consequences will be.
In January, high yield benefitted from strong technicals and solid new issuance – the third strongest January on record, but down year‐over‐year. Going forward, we believe high yield fundamentals remain strong. Refinancing risk remains low and balance sheets are solid. We believe given these favorable conditions, the low default rate of the last couple of years should continue and, as such, we are expecting defaults, in-line with consensus, to stay below 2%, excluding any potential impact of a large Leveraged Buyout (LBO) default which has been rumoured in press articles. Our expectation is for 2014 high yield returns to be largely sourced from coupon. With average prices recently above par, there is little room for capital appreciation in high yield at this point, particularly if we hit a rising interest rate environment.
Strategic mergers & acquisition (M&A) activity is likely to increase to a greater degree than large LBO announcements in the high yield market as large LBO deals still find it challenging to receive significant bank financing. As lenders, we generally prefer strategic M&A, but will continue to watch carefully for signs that borrowers are able to borrow more aggressively. We sit right now probably in the middle of the credit cycle, with some balance between lenders and borrowers. Despite record new high yield issuance in 2013, we do not yet see the extremely loose lending standards present in the 2006-2007 pre-crisis market. Strategic M&A could provide good investment opportunities in 2014, as it did in 2013, as higher rated businesses make strategic acquisitions creating instant price appreciation for those high yield bonds issued by companies acquired. We think that the energy and healthcare sectors will experience further consolidation.
We believe there inevitably will be periods of volatility, but as in the past year, these periods will be driven by headline events and not credit deterioration. This should give rise to investment opportunities in bonds that have good fundamentals but are generally more volatile in nature because of their liquidity profile. We also find good values in high quality, high yielding BB issues that were issued a couple of years ago. While we found them unattractive when first issued because they were longer in duration and offering little yield, we are now willing to take on the incremental duration risk since a couple years of interest has been paid down. The key will be to correctly identify the bonds that offer the best relative value and take advantage of these opportunities when the markets are soft. We continue to prefer carefully-selected duration risk to the lowest-rated credit risk when looking for yield.
Employee Spotlight: Tyra L. Lydon,
30 years experience
You recently celebrated 30 years at AAM. How would you say AAM has grown and changed over those years?
I was hired in 1983 and was the fourth employee, in addition to the three founding members, who were the firm portfolio managers. I was the receptionist, secretary, and in 1984 I started the Settlements Department.
I’ve seen the company grow from 4 employees with only a few clients to 46 employees with 98 clients representing $15.63 billion in assets under management. In 2004, we changed the firm name and moved to a beautiful new office in 2013.
What has been the most significant change?
Technology. In 1983, I started the Settlements Department with the Apple II Computer system which was hooked up to an IBM Selectric Typewriter which allowed us to generate client hard copy confirmations and client presentations. Also, when it came time to distinguish yield curve data, I would have to apply pieces of various colored tape to each yield curve.
Today, we have a network with multiple servers and multiple complex systems for portfolio management and research analysis, a flexible client reporting system, and a Client Relationship Management (CRM) system to help us effectively serve our clients.
What are some of your most memorable experiences?
In 1990, AAM introduced job-sharing opportunities to the firm. I went from working full time to 2 – 3 days a week, on average, for ten years, which allowed me to spend more time raising my children. In addition, I was able to keep my salary and all of my benefits. This generous policy positively impacted every aspect of my life, and I still feel the effects even to this day.
We’ve always had a collegial office culture, and this has been reinforced by our office parties and company outings. These events have given me an opportunity to meet the spouses of the people I work with and to learn more about them and their families.
And recently, I was given special recognition by John Schaefer for 30 years of service at our annual holiday dinner which included a thoughtful gift from the firm.
What are some of your outside interests?
I have a special interest in sustainable organic urban farming with the intent of teaching those in under-resourced communities how to grow their own nutritional food. Currently, my backyard is being used as a testing ground for this project. Whole Foods has generously offered to fund and partner with our farming group to launch future projects.
Once the urban farming project is underway, I plan on experimenting in my basement with Aquaponics (the marriage of aquaculture (raising fish) and hydroponics (the soil-less growing of plants) that grows fish and plants together in one integrated system.).
What would people be surprised to know about you?
I make my own body care products and everyday household items with natural ingredients, such as moisturizers, hand creams, lip balms, laundry detergent and dog treats.
AAM Thought Leadership Articles
AAM produces a number of Thought Leadership articles throughout the year regarding such topics as sector analysis, market conditions, and investment accounting updates. Below is a list of the Thought Leadership produced recently with direct links to the articles.
AAM 2013 Sector Review and 2014 Outlook
Economic growth accelerated during the second half of 2013 boosting optimism for growth going into 2014. Real GDP increased 3.2% Read more…
Captive Insurance 101 and Key Considerations for an Investment Plan
Captive insurance is a subsector of the insurance market that has grown over the past 30 years. The number of Read more…
Puerto Rico Downgrade: More to Come?
The Commonwealth of Puerto Rico’s general obligation debt was lowered to below investment grade (BB+) by Standard and Poor’s on Read more…
AAM Investment Accounting Update – Year End 2013
This memo summarizes the key investment accounting updates from the NAIC and FASB, which will potentially impact AAM clients. These Read more…
AAM Supports Breast Cancer Awareness
For the last six years, AAM employees have contributed $5.00 every Friday during the month of October to be able to wear jeans as part of our Breast Cancer Awareness campaign. Over those years, nearly $2,000 has been donated to the Susan G. Komen Foundation, Bright Pink or the Triple Negative Breast Cancer Foundation. Last October, employees were encouraged to wear pink on the last Friday of the month, to show their support for the cause.
In The Pink!
Front Row: John Olvany, Jon Benstead, Brad McDonough, Gary Alvarez, Chris Frigo, Joe Borgmann; Second Row: Beth Sanford, Eric Pochyla, Stacy Crook, Anna Hawthorne, Darlene Richards, Jeff Martinkus, Neelm Hameer, Sahar Maleki, Kathy Ryan; Third Row: Steve Murphy, Mike McClain, Reed Nuttall, Sebastian Bacchus, Allison Weisnicht, Colleen Herron, Denise Madison, Lori Waite; Back Row: Mike McLaughlin, Mike Kelch, Scott Skowronski, John Schaefer, Colin Dowdall, Dan Byrnes, Mike Ashley
AAM in the Community
For the last seven years, AAM has forged a very successful partnership with the United Way. Beyond raising over $76,000 in financial support for the organization, AAM has participated in the United Way Volunteerism Program.
Two important United Way community volunteer initiatives this winter included:
- In November, AAM employees packed boxes of non-perishable food items for senior citizens at the Mac Warehouse for Catholic Charities. Nearly 1,200 boxes were packed (photos below), bringing the total to over 5,000 boxes packed for senior citizens over the last four year period.
- During the holidays, AAM employees donated toys, warm hats and gloves to the Children’s Home + Aid Toy Drive. This was the third successful year of participation for AAM and is expected to continue.
AAM will be attending and/or participating in the following industry conferences.
[event-list start-date=”3/1/2014″ end-date=”5/1/2014″]
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For more information about AAM or any of the information in the AAM Newsletter, please contact:
Colin Dowdall, CFA, Director of Marketing and Business Development
John Olvany, Vice President of Business Development
Neelm Hameer, Vice President of Business Development
Disclaimer: Asset Allocation & Management Company, LLC (AAM) is an investment adviser registered with the Securities and Exchange Commission, specializing in fixed-income asset management services for insurance companies. This information was developed using publicly available information, internally developed data and outside sources believed to be reliable. While all reasonable care has been taken to ensure that the facts stated and the opinions given are accurate, complete and reasonable, liability is expressly disclaimed by AAM and any affiliates (collectively known as “AAM”), and their representative officers and employees. This report has been prepared for informational purposes only and does not purport to represent a complete analysis of any security, company or industry discussed. Any opinions and/or recommendations expressed are subject to change without notice and should be considered only as part of a diversified portfolio. A complete list of investment recommendations made during the past year is available upon request. Past performance is not an indication of future returns.
This information is distributed to recipients including AAM, any of which may have acted on the basis of the information, or may have an ownership interest in securities to which the information relates. It may also be distributed to clients of AAM, as well as to other recipients with whom no such client relationship exists. Providing this information does not, in and of itself, constitute a recommendation by AAM, nor does it imply that the purchase or sale of any security is suitable for the recipient. Investing in the bond market is subject to certain risks including market, interest-rate, issuer, credit, inflation, liquidity, valuation, volatility, prepayment and extension. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission.
Disclaimer: Asset Allocation & Management Company, LLC (AAM) is an investment adviser registered with the Securities and Exchange Commission, specializing in fixed-income asset management services for insurance companies. Registration does not imply a certain level of skill or training. This information was developed using publicly available information, internally developed data and outside sources believed to be reliable. While all reasonable care has been taken to ensure that the facts stated and the opinions given are accurate, complete and reasonable, liability is expressly disclaimed by AAM and any affiliates (collectively known as “AAM”), and their representative officers and employees. This report has been prepared for informational purposes only and does not purport to represent a complete analysis of any security, company or industry discussed. Any opinions and/or recommendations expressed are subject to change without notice and should be considered only as part of a diversified portfolio. Any opinions and statements contained herein of financial market trends based on market conditions constitute our judgment. This material may contain projections or other forward-looking statements regarding future events, targets or expectations, and is only current as of the date indicated. There is no assurance that such events or targets will be achieved, and may be significantly different than that discussed here. The information presented, including any statements concerning financial market trends, is based on current market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons. Although the assumptions underlying the forward-looking statements that may be contained herein are believed to be reasonable they can be affected by inaccurate assumptions or by known or unknown risks and uncertainties. AAM assumes no duty to provide updates to any analysis contained herein. A complete list of investment recommendations made during the past year is available upon request. Past performance is not an indication of future returns. This information is distributed to recipients including AAM, any of which may have acted on the basis of the information, or may have an ownership interest in securities to which the information relates. It may also be distributed to clients of AAM, as well as to other recipients with whom no such client relationship exists. Providing this information does not, in and of itself, constitute a recommendation by AAM, nor does it imply that the purchase or sale of any security is suitable for the recipient. Investing in the bond market is subject to certain risks including market, interest-rate, issuer, credit, inflation, liquidity, valuation, volatility, prepayment and extension. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission.