Portfolio Manager Perspectives

Jeff Benjamin

Looking under the hood of an ESG-focused high-yield bond fund

Portfolio manager Tim Leary admits it isn't always easy being green

Nov 18, 2019 @ 1:41 pm

By Jeff Benjamin

Tim Leary took over as lead manager of the RBC BlueBay High Yield Bond Fund (RGHYX) in January 2017, 10 months before the fund was converted to focus on environmental, social and governance causes.

Mr. Leary, 37, admits that at times he's climbing the steep side of the mountain by adding ESG screens to a corporate high-yield bond fund as global central banks are driving down yields, but he insists this is not a "greenwashed" fund.

The ESG focus, he explained, is designed to leverage the expertise of BlueBay Asset Management, the $60 billion London-based credit specialist subsidiary of RBC GAM, a $345 billion global asset manager.

The $54 million fund, which was launched in 2012, has an expense ratio of 58 basis points and a five-star rating from Morningstar. It has gained 13.7% from the start of the year, beating both the benchmark and the category average.

Jeff Benjamin: What type of investor would be interested in your fund?

Tim Leary: This fund will do well with folks who believe in the BlueBay process and see value in the high-yield asset class over the cycle, and are very comfortable with managers that will manage a portfolio that doesn't look like any benchmark or index. That's been a real source of our alpha that we've been able to generate.

There's 840 or so issuers in the index and we manage a book of 100, so you have to find investors that are comfortable taking that kind of differentiated risk.

JB: Can you elaborate on that differentiated risk?

TL: We are investing our clients' money and lending it to corporations, and it's our job to get that money back with interest. It's really as simple as that. When you take the view that you're good at what you do in identifying good companies, you shouldn't be afraid to take concentrated risks on a name-by-name basis.

It's unusual to have a portfolio of 100 names or so, which just doesn't look like the index.

We have the ability to take specific stories and sector weights that reflect our view from both top down and bottom up, and we think that's a real added value.

[More: ESG data getting better as the market matures]

JB: What's the story behind the fund's ESG focus?

TL: We launched in2012a '40-Act version to mirror our global high-yield product, and at end of 2017 we made the decision to change the benchmark to U.S. high yield and to make it officially an ESG fund.

Going back five years or so, our ESG team was brought on and we've integrated ESG awareness and standards throughout the entirety of the firm, and two years ago we decided to make this an ESG fund when we changed the benchmark. ESG is an underwriting risk mitigant in the credit underwriting process.

JB: Can you explain the ESG screens and what they mean with regard to this fund?

TL: This is not a greenwashed fund. ESG is integrated into our process. When we underwrite an individual risk, there's a two-part process that involves the credit analyst and our ESG specialist. Between those two individuals, we come to a fundamental ESG score.

We certainly do make use of the various rating agencies regarding ESG availability. I think that's a good starting-off point. The rating agencies are helpful in that regard, but I think they can be backward-looking, and we are focused on doing our own proprietary work.

When we think about ESG, we think about it as a risk mitigant and we think about it as an alpha source. The goal of the fund is to generate top-tier returns for our clients. We just do it in a way that minimizes ESG risk.

When we changed the benchmark, we intentionally chose U.S high yield and not an ESG index because we want to show investors that our way of underwriting risk is going to beat any benchmark, not just ESG benchmarks.

JB: Does ESG screening handicap you relative to other high-yield bond funds?

TL: It's a question we think about often. In times when the markets are rallying, sometimes indiscriminately, oftentimes you feel like it's impossible to keep enough risk on the books.

Other times it feels like it's a hindrance. We don't feel that way on the whole.

Our ESG process allows us to take the right kind of risks that are commensurate with our view on the market. We broadly think we're constructive on the high-yield market right now. Defaults are low, spreads are fair value, there's enough carry there, credit markets are supportive, we like high yield. We just need to be continuously diligent around the types of assets we invest in.

JB: Why was the fund converted to ESG?

TL: Because we think that we're good at it, and we're ahead of the game, given our European background. I think it's going to be a source of growth in the United States and a real value source for investors.

JB: Can you sum up your investing style and approach to portfolio construction?

TL: The leveraged finance markets and high-yield markets in general are a risky place to invest because they tend to be more opaque.

Our style involves getting to know management — looking management in the eye and understanding if we want to lend that company and that management team money.

The fact of the matter is if a company won't take our phone call, then we can't invest.

Part of the reason why we runas concentrated a riskas we do is many companies won't provide the touch points that we need.

JB: Your fund has an average annual turnover rate of 158%. Is that something investors should get used to?

TL: You're going to see slightly elevated turnover across many strategies within BlueBay. We adhere to strict stop-loss and spread target methodologies.

When bonds reach our fair value, we don't have a problem trading out of it.

We always seek to minimize trading costs but we're also not afraid to trim and take positions on and off.

[Recommended video: Michael Kitces: IBDs can't match discount brokers on zero commissions]

JB: How difficult is it to find yield in this environment?

TL: Central banks around the world have done a terrific job of pushing investors into the deep end of credit markets.

It's made the markets riskier. We think our approach and diligence will be a huge advantage down the line when that policy changes.

It is difficult to find yield and the trick is to make sure that you're not lulled into complacency. You can't take bad risks in the high-yield market because you will lose alpha, you will lose principal and you will lose investors.

JB: Where are you seeing the most opportunities?

TL: From a sector standpoint, we tend to be overweight financials, as well as financial services companies, cable and media names. Both from an ESG perspective but also from an overall view, we are materially underweight energy, metals and mining, and utilities.

While we do not think a recession in the U.S is imminent, and when it comes we think it will be a shallow recession, we do think that as the cycle grows longer, now may not be the time to be invested in cyclicals.

JB: What are the biggest challenges you face managing this fund?

TL: The biggest challenge is not be afraid to say no. When a coupon or high-yielding opportunity comes along, but you know it's not the right risk for the long term, you just have to be confident in yourself to say no. That said, when you think you have the advantage, you have to have the confidence in your process to make big investments when you've done your work properly.

JB: Where do you think things are going in high-yield space over the next year to 18 months?

TL: We're generally bullish on high yield.

I think the technicals will remain very supportive. There's negative net supply in the market so there isn't an incredible amount of new issuance that needs to come and clear. Balance sheets are in relatively good shape.

Generally speaking, it's one of the few places globally to pick up yield in a low default environment.

That said, and I can't stress this enough, it's utterly important to avoid situations where there's real risk of downside in individual stories.

[More: 10 leaders of ESG & impact investing]


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