abrdn Income Credit Strategies Fund (ACP) Update - March 2024

In this episode, George Westervelt joins Mike Taggart to give an update on ACP. 

Transcript

Mike Taggart 00:02

Welcome to the latest podcast through the Aberdeen income credit strategies fund ticker symbol ACP. I'm Mike Taggart, Aberdeen's us closed end fund Specialist. Today we have George Westervelt. Aberdeen's Head of Global high yield investments in a portfolio manager on ACP. George, thank you for joining us today. 

George Westervelt 

Thanks for having me Mike. 

Mike

George, I want to start off with ACPs investment team, in terms of the portfolio managers, you and Matt cancer here in the US, while Ben pack and him and Adam table are in London, can you walk us through the size of your analyst team, your team's research and investment processes, how it's all structured? And how you construct the portfolio?

George 00:43

Of course, well, thanks again, Mike. There's a lot to unpack there in that question, so let me just first start with the team. So yes, it's a team of four people managing the fund. It's the same pm team that manages all of our global high yield strategies. We've Adam and Ben in London, as you mentioned, and Matt, myself are located in Boston, but you know, honestly, in this day and age, location matters very little as far as how we communicate, it's it's pretty seamless. So

George 01:13

this team, we've been managing high yield funds together since 2017. In fact, I was doing this math the other day, Matt and I have been working together for almost 18 years, which I say that out loud, it's scary. But there's a lot of benefits to that working together for that long, and having a close knit team. So you know, the communication, it's seamless across our pm team, whether it's, you know, talking on IB chat on Bloomberg, which is our instant messaging on Bloomberg terminal, scheduled meetings that we have, we have our daily meetings where, in the morning, the analysts run through company news, Tuesdays and Thursdays, we also have a meeting that goes into more of a deep dive on movers and shakers, for the respective analysts. And then we have ad hoc VC calls throughout the day. But the point is, we're constantly talking as a group in order to try and identify the best investment opportunities for for not only for ACP, but for all the funds that we manage.

George 02:09

You know, I would remind you to the ACP, it's a global high yield fund, right? This isn't just a US high yield fund, we're not constrained to us. So that provides us with a bigger, bigger pond efficient, if you will, broader opportunity set. So we can really look across that global universe holistically when we're managing this fund, which is a big benefit.

George 02:32

Currently, the fund is roughly 50/50 In terms of US and European holdings that can fluctuate fluctuates over time. But that's where we fall right now. It really just depends on where we see value. So we have the ability to go where where we see the value.

George 02:49

I would also say that, you know, as we go deeper in the team, here, we're talking about the analysts pool, that's a very experienced, analyst pool. We've got boots on the ground, multiple geographies. And really, it's a great, it's a great team. It's approximately 23 investment professionals dedicated to the high yield strategies. And that's just developed markets. So in addition to our developed market,

George 03:15

depth, we have a very large and reputable EM team that we rely on to for non developed market investment ideas. So yeah, we're well stocked as far as, you know, the research capabilities to manage a global fund, such as ACP. And we really do think it's important, I think it's worth mentioning that is important to have those full scale teams and local markets. When you're analysing companies, you want to make sure that you're not doing it from afar, it's much more beneficial to have those boots on the ground in local markets, and really be able to understand those drivers. And that's something that we benefit from. So that's the people. As far as the second part of your question process. We could spend a while talking about process, but I can just go through quickly and give you kind of the whistlestop tour. So a couple things to highlight, we run a bottom up fundamentally driven investment process. So what's that mean? Well, it means that we're starting at the company level, right? This isn't a macro driven fund, we consider the macro, but we're not starting at the top and then then filling buckets. We started the company level, we're analysing the fundamentals of the companies, we're identifying the drivers were modelling of cash flows, and digging through the covenants and you know, all that work. That's basically the nuts and bolts of what we do day in and day out. And so it's the backbone of our process.

George 04:44

So once we go through and we do the fundamental work, then the next step after that is, is valuation and that's a really important part of what we do and how we how we've been so successful in managing our

George 05:00

funds a key part of what we stress with the analyst. We really want our analysts to be investors, we don't we don't want them just to be research analysts to take it to the next step, which is, is basically seeing that investment idea all the way through, anyone can rip apart a balance sheet and analyse the cash flows. But then you have to be able to translate that into the most important question, which is, am I getting paid for the risk in this bond?

George 05:28

So yeah, we're thrilled with our analyst team, and the depth of investing acumen there. And it's really an impressive team of individuals.

George 05:37

And as finally, the last part of your question was just about portfolio construction. So where do we as the PMs add value? Well, really, it's, it's driving those conversations, it's challenging the analysts in a constructive way, of course. But then it's it's kind of gathering all those best ideas and building a diversified portfolio out of those best ideas that that meets Well, I would say, exceeds the needs of the client.

George 06:05

Every strategy has its own idiosyncrasies, and ACP definitely has its, you know, given the focus on generating a high level of, of income. So there's a host of considerations that obviously come into play when we're managing a fund like ACB. But, you know, if we just step back and strip it all down, it really comes back to just you got to get that credit selection, right. And that is paramount to success.

Mike 06:31

Well, so thank you for the thorough answer. Sounds like a large, high quality analyst team backing up, they're doing a lot of good, solid, fundamental research, all coming together to provide that current income for investors. So, you know, right now, why should investors consider allocating capital to high yield securities in the current environment? 

George

Sure. Well, you know, this claim, that's by saying I'm partial high yield, obviously, I do think that high yield is quite attractive in the current environment. And give me a couple of reasons why. I mean, if we just quickly look back, it's been a wild time to be an investor over over recent years. And just think about what we've gone through. I mean, not only is investors but as a human race over the past five years. So

George 07:18

markets have been driven, I guess, probably, perhaps more than I've seen it in my, in my career by the macro environment, right. Central banks have really dictated the risk appetite of, of investors over over that period. But I guess amidst that backdrop, there's been a lot of excellent opportunities to make money and not not just in high yield, not just in equities, but a variety of asset classes.

George 07:43

We think that continues going forward and high yield, we really do think it's set up well, for for some impressive total returns over coming years.

07:51

Duration was the story in 2022, as central banks were fighting inflation that had some negative impacts on total returns for fixed income, especially as you went higher up in quality. And then last year, it was the fear of recession that held markets back at least initially, which changed throughout the year. But but now we're in this period where inflation has come down precipitously.

George 08:16

So the macro drift backdrop is stabilise and company fundamentals are really good enough. You know, and they're stable. yields in the asset class are offering high US high yields dealing close to 8%. Right now. So that's an equity like returns. So you're getting a nice coupon, you know, a nice yield to

George 08:38

invest in the asset class, you have some positive drivers behind you and a lack of headwinds that have faced us over recent years. So

George 08:46

pretty positive for the asset class. I think if we're, if we're honest, it's probably difficult to argue that spreads are cheap here. You know, if you look back at historical averages, but, you know, there's there's a lot of ways to justify that. considering both the Olin yield, as I said, almost 8%, and then it's just the overall quality of the high yield universe at this point. We're in we're in good shape fundamentally. So valuations look appropriate to us. One other thing I point out is the beauty of the high yield market is this the safety mechanism of a running yield. So you have that 8% you're clipping that as long as the market stays stable,

George 09:28

which cushions downside return potential if things do go the other way. But it also supercharges the upside if, if spreads continue to tighten. So you come up with a variety of pretty positive outcomes as far as total return. So yeah, for sure. We see. We see today's market is a compelling option for investors. I guess we want to capture both that attractive yield and and generate total return in a fundamentally supported high yield market. 

Mike

All right, great. And so then, you know,

Mike 10:00

Just looking at your current fact sheet on ACP, you know, I see that over 50% of the portfolio is in B rated securities, which, you know, I believe is an overweight allocation. But for a high yield fund, can you can you help us, you know, listeners and myself put that allocation wading into kind of plain English in terms of the high yield universe? 

George

Yeah, of course. So that's correct. We're right about 50% in ACP as far as single exposure,

George 10:30

corporate credits at the moment. And yet, we see that as the sweet spot in today's market.

George 10:37

As far as the benchmark, we're fairly agnostic, especially in this fund when it comes to the benchmark, but just to provide you and the listeners some context, if you look at the global high yield market as a proxy, it's about 40% single Bs. So yeah, to answer your question, this would be an overweight versus the overall market.

George 10:58

Maybe we should just step back for one quick second for some of the listeners just to explain. So as far as the ratings, so high yield bonds are bonds that are rated below investment grade by the rating agencies, that's s&p, Moody's and Fitch or some combination of the three. So that means anything rated below triple B minus falls into high yield. So you have your double B's, you have your single B's, and you have your triple C's. And that's the risk scale with a triple C's carrying the greatest risk of default. And hence, the most risk double B as being the highest quality of the three

George 11:33

triple C's have done incredibly well over recent years.

George 11:38

If we go back to that 2022 timeframe, triple C's were the top performer, not because spreads tighten as much there. But just because they have minimal duration compared to their higher higher quality cohorts. So less sensitivity to rising government bond yields. And then last year, triple C's were up 20% In the US, which that's a pretty nice return any environment, especially in one where where a lot of people are concerned about a recession. So we've made we've done well in the triple C's the fund was

George 12:14

outsized in the Triple C exposure over recent years. And what we've done recently, Mike is we've we've taken that as an opportunity to lock in some profits, take a bit of risk off the table and recycle those proceeds into credits that are

George 12:29

higher quality,

George 12:31

mostly single B rated credits, and we've done that without sacrificing much in the way of yield and or total return prospects. 

Mike

Okay, interesting. And so then, you know, finally, there's a question that's, you know, typically top of mind for most high yield investors, and that's, you know, the outlook for corporate defaults over the next year. Can you share what your outlook is for such defaults? 

George 

Yeah, yeah, no, it's always a, always a popular question. And maybe the best way to answer this is just to look back a little bit and just explain that. So corporate defaults tend to go through boom, or bust cycles that typically coincide with recessions, right, so you have a corporate default cycle that typically we'll match up with a business cycle, economic cycle.

George 13:23

And we saw that in 2008, when corporate defaults in high yield, were in the mid teens, and then we saw it again in 2020. Not quite to that magnitude. But we did have a few things that happened since the last large recession in in 2008, GFC. So in 2016, we had a mini default cycle that was centered around energy. So within high yield, you had a lot of lower quality energy companies

George 13:57

that ended up filing for bankruptcy. And what that did is it purged the market of the lowest quality energy companies. And then in 2020, with the pandemic, we had a another mini default cycle. And when I say Mini, you know, we're talking about defaults in mid to high single digits. But that, again, was focused around sector specific, it was the consumer, it was leisure and the consumer.

George 14:23

So, you know, looking back, you had these two smaller default cycles that that purge the market of lower quality names in these in these various sectors. what that's done is it's left us with a market that is,

George 14:38

I wouldn't say absent, but it's lacking in, in a lot of troubled, troubled companies at the moment. So, you know, we look at today's constituents, and we just don't see a lot of companies, anything meaningful, that they're really in a bad way right now. So that leads us to believe that the defaults are going to

George15:00

be somewhat contained going forward.

You know, looking out on the horizon, maturities are picking up for sure there's a maturity wall, I would call it more of a maturity fence at this point. Maybe in loans, it's more of a wall, but it's manageable.

George 15:18

And companies, you know, back in 2020, and 2021, they did a really good job of repairing their balance sheets, you had companies that were printing coupons, I can remember, you know, a two and three quarter and a two and seven eighths coupon being printed for high yield companies. I mean, that's, that's unheard of, and that pays dividends going forward, you know, those companies would typically be spending money on interest costs that they were now able to generate that cash flow and, and build up the balance sheet. So

George 15:50

the financials of most companies in general and high yield right now are are pretty good. So I guess there's a long way of saying that we view credit risk on the whole as contained, we think that if we do go into a recession, the fall cycle, or remain fairly muted, versus what we've seen historically. And sure, there's some bad credits out there, there's there's always bad credits out there. But if you are able to do the credit work and trust the integrity of the investment process, the name of the game, you can you can avoid those default losses, and you can generate a really attractive to a return over coming years and in high yield market.

Mike 16:31

Well, excellent. Sounds like there's not a lot of red flags on the horizon. Thank you, George for that update on ACP. It's always a pleasure checking in with you. 

George

Thanks, Mike. I appreciate it.

16:41

And thank you everyone for listening to this podcast. There are three convenient ways to learn more about ACP on the internet, visit abrdnacp.com email us at Investor.Relations@abrdn.com Or give us a call at 1-800-522-5465. I'm Mike Taggart of Aberdeen, thank you for listening.

17:21

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