It's a Market of Bonds, Not a Bond Market

Craig Manchuck: By now, most of our investors have heard us say "It's a market of bonds and not a bond market." And I think the best way to illustrate that is to first look at the investment grade corporate bond market to show how the features of that market are much more commoditized than they are in the high yield market. The investment grade corporate market is about $10 trillion in size. And while different companies issue bonds with different coupons and different maturities, beyond those features, all the other underlying features are typically very similar. They offer relatively few protections for investors other than the coupon and a promise to repay. The high yield market, conversely, while much smaller at $1.7 trillion approximately, offers significantly different features underlying every individual issue. Even within the same company, we often see different features afforded investors in different types of bonds. We have some companies that issue bonds that are secured by collateral and assets that the company owns.

Others will often issue bonds that have restricted payment tests, and those restricted payments tests allow companies to only access money to pay dividends and buy back stock when they are able to reduce their leverage below a certain hurdle rate. Others have change of control. In fact, most have change of control features, which allow investors to redeem their bonds at 1-0-1 in the event of a change of control, which typically often involves a levering transaction, and thereby provides us with some additional protection. So what we try to do is identify the best companies we can find, and then look at each of the individual bonds and make sure that those bonds are offering us the protections that we need so that there is adequate downside protection, should things not go as planned and that doesn't allow company managements to take money away from bondholders and away from the company that should be being put to better productive use.