SOURCE: Scott's Cove Management LLC

Scott's Cove Management LLC

December 04, 2013 12:19 ET

The Right Mindset for Corporate Credit Investing in 2014

Investing in a Subset of U.S. Corporate Bonds Could Provide Solid Returns in 2014 Without Unnecessary Risk, According to Scott's Cove Management LLC

NEW YORK, NY--(Marketwired - Dec 4, 2013) - Many investors believe 2014 will be a dangerous time for corporate credit and that they should thus avoid the asset class. Federal Reserve tapering and rising interest rates could lead to zero returns (aka "dead money") or even significant capital losses. 

But steering completely clear of corporate bonds may not be wise, since the right ones may still, as history suggests, offer the potential for solid returns and significant downside protection, according to Scott's Cove Management LLC, an event-driven corporate-credit-focused investment manager.  

Scott's Cove Senior Portfolio Manager Phillip Schaeffer says investors may be well served to adopt a mindset regarding corporate bonds that is based on the following suggestions and insights:

  • Minimize interest-rate risk. Look for shorter maturity, higher coupon corporate bonds -- i.e., those with shorter durations. If a bond is trading at a large spread over the risk-free rate, it is less likely to decline in price due to significant increases in Treasury rates.

  • Look to obtain returns not from interest rate declines, but from good analysis. The easy money from holding a portfolio of just about any fixed-income instruments during a period of declining interest rates is over. Rather, search out event-driven opportunities -- e.g., securities that are the result of restructurings, bankruptcies or liquidations; candidates for re-financing; or corporate activities like acquisitions, asset/division sales, litigation, tax issues or other types of extraordinary events -- or companies recovering from them. In short, bottom-up, fundamental analysis is one of the best ways to protect capital.

  • Smaller bond issues provide better value. Like a crowded stock trade, the largest bond issues (and the high yield ETFs which own them) often move based more on market sentiment than on fundamentals and hence tend to provide less value. However, bonds of smaller, less-followed or less-glamorous companies or industries are often characterized by market inefficiencies and thus offer the best potential for compelling risk-adjusted returns. 

  • Look to secured debt to help protect against volatility and mitigate loss of principal. To reduce the risks associated with market, economic and even company-specific volatility, look to bonds that are secured by legitimately valuable assets of the issuing company. These will perform better than unsecured debt in turbulent environments.

  • Be honest about the risks you are taking and the returns you expect. Carefully chosen, event-driven bonds, while rarely offering the "homerun" returns possible in the stock market, can provide solid, consistent performance over time with a much lower risk profile. This could help offset the drubbing that stock valuations and multiples could take if interest rates rise when the Fed's tapering begins in 2014.

"By taking a smart and patient approach to this niche area of the corporate credit market, investors can expect a high likelihood of not losing money, along with good, 'Steady Eddie' returns," Mr. Schaeffer says. "It's a compelling alternative to both the equity and more mainstream fixed income markets."

About Scott's Cove Management LLC

Scott's Cove Management LLC (SCM) is an event-driven, long-short, credit-focused investment manager whose objective is to protect capital and generate compelling absolute returns over all market environments. On the long side, SCM focuses primarily on senior and secured debt of lesser-followed high-yield corporate issuers, including distressed situations. On the short side, SCM seeks fundamentally overvalued and economically deteriorating issuers, often as a hedge to protect the portfolio. SCM (including its predecessor firms) was founded in 1991 and is based in New York. For more information, please visit www.scottscove.com.

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