LBO junk bonds getting risky, Old Mutual’s Meigs warns

BOSTON (Reuters) – The key to running a high-yield debt fund is discipline and a sixth sense to avoid risk, according to Edward Meigs, co-manager of the Old Mutual Dwight High Yield Fund (ODHYX.O: Quote, Profile, Research).

Right now is a time to be wary of deal-related bonds, Meigs said.

“The pendulum has swung in favor of issuers,” he said. “It’s a time when you’ve got to be extremely careful in reading the covenants and keeping your credit discipline in the face of market euphoria.”

That means favoring the more steady and defensive issues, Meigs said. He expects the high-yield market overall will still outperform a weakening Treasuries for the rest of the year even as problems build up in the deal sector.

The $11 million Old Mutual Dwight fund was the Lipper award winner in the high yield bond category. The award recognizes consistent performance over three years adjusted for the amount of risk the fund took.

The fund gained an average of 16.03 percent annually for the three years ended December 31, 2010, better than the category average of 7.11 percent a year, according to Lipper.

Meigs and co-manager Sean Slein, who are based in Baltimore, try to focus on the somewhat predictable cycles that the high-yield market passes through. A strengthening economy encourages high yield issuers and investors to take more and more risk on credit quality and eventually ends in a bust.

“The key driver of performance is the way we moderate the risk of the portfolio depending on where we are in the credit cycle,” Meigs said.

That led the pair to tamp down the fund’s risk level starting in 2006. By the time the credit crisis hit in 2008, the fund was concentrated in shorter maturities with lots of steady industrial and energy sector issuers. Lowest rated CCC bonds and debt that came from leveraged buyouts were scarce.

“We felt a lot of those deals were done at unsustainable debt levels,” Meigs said.

In 2009, it was time to go bargain hunting, which bolstered performance in 2010 and 2011.

Issuers in the leisure sector were crushed on fears that consumers would stop spending for vacations. Meigs was able to buy bonds issued by the Royal Caribbean cruise line due in just a few years for 70 cents on the dollar, for example.

The bonds traded up into the 90s and Meigs has reinvested in longer-term debt from the same issuer.

(Reporting by Aaron Pressman; Editing by Walden Siew)

LBO junk bonds getting risky, Old Mutual’s Meigs warns