Description
Artisan Partners Credit Team
Investment Philosophy and Process
Artisan High Income Fund
. 90
150
Analysts:
Joanna L. Booth, CFA
60
120
John T. Basler, CFA
Joseph G. Dawson, CFA
Bryan C.
Krug, CFA Portfolio Manager Scott J. Duba, CFA Scott P. Baker 30 W West (-) Our team was built from scratch to best 0 our investment philosophy suit and process. 90 Artisan Partners Credit Team Our Investment Team Our investment team has been built with one simple goal—to bring together a group of experienced investment professionals who excel at performing deep, fundamental credit work.
Our team, headed by a portfolio manager, is supported by analysts and a trader dedicated solely to one investment philosophy and process. While the process is a collaborative effort that allows the team to leverage internal resources and expertise, final decision-making ability lies with Bryan Krug, the Portfolio Manager. Together with Bryan, the analysts, as members of the research team, perform bottom-up credit analysis. As a small and nimble team, we maintain a generalist approach to research with sector tendencies.
We believe our broader perspective is beneficial—avoiding strict sector designations helps eliminate blind spots and missed opportunities. In addition to conducting his own research on certain names, Bryan is responsible for portfolio management and allocation. Our Investment Philosophy We have developed foundational beliefs about the non-investment grade credit market as a result of our many years investing in the asset class. Honed over up and down markets, these tenets form the core of our investment philosophy. First, we believe that the non-investment grade market has cyclical, industry and company-specific dislocations which we can exploit.
Cyclical dislocations are typically driven by the credit cycle. Industry dislocations stem from the profit cycle of a specific industry. Company-specific Artisan Partners Credit Team—Investment Philosophy and Process dislocations are those in which we have an out-of-consensus view about a company’s trajectory from which we believe we can profit. Second, we believe we can find the best risk-adjusted return opportunities through fundamental credit analysis and value identification across the capital structure.
We believe the market is innately complex and securities are frequently mispriced, which benefits investors who are willing to perform detailed, bottom-up analysis. Finally, we believe attractive risk-adjusted returns can be achieved over a full credit cycle with a repeatable, high-conviction investment process. We are not looking to achieve index-like returns. Our goal is to use the investment freedom we have to build a focused portfolio of non-investment grade securities that have the potential to add value over the long term. Our Investment Process Our goal is to invest in issuers with high-quality business models that have compelling risk-adjusted return characteristics.
As active managers with high degrees of freedom, we believe the disciplined execution of our process will enable us to build a portfolio of securities that can perform well regardless of the market environment. Idea Generation The first step of our investment process is idea generation. Our area of focus is the non-investment grade credit market, comprised primarily of high yield bonds and leveraged loans. We believe it is a deep market with an ample opportunity set. .
We are not geographically constrained, but our expertise and experience built over the years has led us to focus primarily on US-based issuers. Occasionally there are attractive investments outside of the US, most commonly in Europe. Idea Generation Quantitative Screens Qualitative Factors BUSINESS EVALUATION Fundamental Credit Research Business Quality Financial Strength & Flexibility Downside Analysis Value Identiï¬cation RELATIVE VALUE Portfolio Construction Core 20%-60% Spread Tightening 10%-50% Opportunistic 10%-30% One source of ideas is our customized quantitative screens that pull a variety of index constituent data on a daily basis. We use the screens as a mechanism to narrow down the investment universe, which includes over 1,500 issuers in the bond and loan markets, taking into consideration that some issuers offer bonds and loans. Screens are based on characteristics such as yield, performance and relative value across and within sectors.
If any security, grouping or pattern stands out to us, we will take a closer look. Non-quantitative methods are also employed for idea generation, including monitoring credit trends and attending industry conferences. We also draw on our network of buy-side, sell-side and private equity relationships. The primary market, in which banks facilitate new transactions between borrowers and lenders, is a natural source for new ideas. We are selective when it comes to participating in primary transactions. The deals brought to market by non-investment grade issuers may feature complicated corporate and capital structures and unique covenant packages.
Each financing is unique. Doing a thorough, detailed review on the credit as a whole and the transaction in particular is always necessary. Though some may think the primary market is a convenient source of supply, we think investors who breeze through the details are often those who end up on the wrong side of the risk-reward equation. Idea generation is the starting point of our process.
The result is a list of investment candidates that we dive into deeper during the most crucial step of our process—fundamental credit analysis. This is where we spend most of our time and what ultimately drives our outcomes. Fundamental Credit Analysis Fundamental credit analysis is the core of our investment process. It requires passion and dedication plus a significant amount of time and effort, but we believe this is where we add the most value. We rely primarily on self-generated research.
To enhance and amplify our own proprietary models, we make use of external resources. As a matter of course, the investment process generally includes conversations with company management, industry experts and competitors and we will, from time to time, engage consultants with industry expertise to provide detailed information specific to individual investment ideas. We believe that accessing third party resources and expert networks helps to build a complete understanding of the company, its management and its capital structure.
We also draw on our network of buy-side, sell-side and private equity relationships throughout the process. Furthermore, we do extensive document review (again, with a third party’s assistance) to ensure comprehensive understanding of the debt capitalization, covenants, etc. We believe cohesion and dedication to a unified philosophy and process are necessary ingredients for successful investing. As such, daily communication and collaboration are key ingredients to our overall process.
We usually gather as a team twice daily. During our regular morning meeting, we cover market color, the new issuance calendar as well as activity and movers in the secondary market. We also broadly communicate what we are focused on that day. As active managers with high degrees of freedom, we believe the disciplined execution of our process will enable us to build a portfolio of securities that can perform well regardless of the market environment. .
Our daily lunch meeting is more in-depth. This provides the team a forum for comprehensive discussions about our current credit work, research findings and investment ideas. Team members present ideas and field questions within an active dialogue. We believe that this collegial approach provides us with relative value perspective across sectors, and prevents us from becoming too blinkered with regard to our own areas of focus.
Detailed research notes and financial models are maintained within our internal research platform. Ad hoc discussions occur on a regular basis in our Kansas City office, typically when there is a company-specific news item or research updates to existing or potential holdings. In addition, each position in the portfolio also undergoes an in-depth quarterly re-underwriting process. Meetings are held with each of the analysts individually to rigorously evaluate all owned names, taking into account any recent corporate developments, company earnings and current market conditions.
By doing so, we can determine if the investment thesis holds true and/or other current opportunities are now more compelling. The team’s analysts spend the vast majority of their time on research, while our trader is responsible for executing on trade decisions made by the portfolio manager. Our trader works very closely with the team’s investment professionals to ensure ongoing information is shared, including news related to portfolio companies, planned changes in the portfolio, and market and trade activities/ developments. We consider trading to be a value-added process. Our analysis is based on four pillars: â– Business Quality A variety of sources are used to understand the resiliency of an issuer’s business model.
We analyze the general health of the industry in which an issuer operates, the issuer’s competitive position, the dynamics of industry participants and the decision-making history of the issuer’s management team. Fundamental Credit Analysis In the non-investment grade credit market, we are attracted to companies with resilient business models and strong competitive positioning which we believe will show profit improvement and financial deleveraging. Businesses with recurring revenue and low capital intensity are appealing as they tend to have predictable revenue streams. Our analysis is based on four pillars: â– Business Quality â– Financial Strength and Flexibility â– Downside Analysis â– Value Identification Porter’s Five Forces Analysis is utilized to understand the competitive position of a business. This tool gives us a framework to assess a company’s buyers, suppliers, competitive rivalry, the threat of new entrants and the threat of substitutes. â– Financial Strength and Flexibility Every capital structure in the non-investment grade market is constructed uniquely and some can be complex.
Generally, we embrace complexity. A lot of investors shy away from the work, but we appreciate the prospect of unearthing opportunities by committing time to do the research. This level of analysis allows us to participate in what we deem to be the optimal risk-adjusted portion of a company’s capital structure. Analyzing the history and trend of free cash flow generation is critical to understanding an issuer’s financial health in this process.
The financial analysis also considers an issuer’s capital structure, refinancing options, financial covenants, amortization schedules and overall financial transparency. Some of the ratios evaluated include free cash flow to debt and debt to implied enterprise value. We will further evaluate two-year deleveraging at various points within a capital structure. This process leads to a portfolio of businesses with potentially strong and improving free cash flow to debt. â– Downside Analysis We believe that credit instruments by their nature have an asymmetric risk profile—the risk of loss is often greater than the potential for gain, particularly when looking at non-investment grade issuers.
As debt holders, we have to focus on what can go wrong. We seek to mitigate this risk with conservative financial projections that account for industry position, competitive dynamics and positioning within the capital structure. There is also an avoidance of companies we believe are overrated or have the potential for credit deterioration. Artisan Partners Credit Team—Investment Philosophy and Process .
We have an unwavering focus on risk-adjusted return potential and upside capture. We believe that margins of safety should not be compromised in the search for yield. When we examine valuations, our goal is to be default agnostic. This means we want to be confident the enterprise value is sufficient to support a return of our invested capital in a default.
This discipline is intended to prevent permanent capital impairment in times of stress. â– Value Identification Multiple metrics are used to determine the value of an investment opportunity. We look for credit improvement potential, relative value within an issuer’s capital structure, catalysts for business improvement and potential value stemming from market or industry dislocations. We are capital-structure agnostic: we pick our spot along the capital structure based on relative value. The portfolio’s split between bonds and loans will always be the result of our bottom-up security selection process.
We think this flexibility to invest along the capital structure is a key differentiator for our strategy. How We Think About Credit Ratings For better or worse, most players in the non-investment grade credit market have credit ratings (as assigned by agencies like Moody’s, S&P or Fitch) on their radar. We describe our investment process as “ratings-aware.” However, investment decisions are made based on fundamental research to determine the creditworthiness of a given company. As a result, we will oftentimes be attracted to businesses that we believe are underrated.
The difference can be partly attributed to divergent views on recovery: the major ratings agencies, in our view, tend to overemphasize hard assets and underemphasize cash flow generated by assets such as intellectual property. In essence, we take on the responsibility for assessing credit risk, rather than abdicating it to the rating agencies. Duration and Other Portfolio Considerations We believe the non-investment grade credit market’s largest sensitivity is to the collective credit environment, not interest rates. As such, duration risk will always be secondary to credit risk for us. Our focus is to manage company-specific risk.
We take on market risk when we make an investment, but above all we try to find opportunities where we can profit from credit improvement. While not required, we usually seek to hedge against the risk of loss resulting from currency fluctuation. We generally do not trade Treasury notes as a means to hedge our interest rate risk. Portfolio Construction We believe individual security selection is the best way to take advantage of the potential opportunities presented by inherently complex and inefficient non-investment grade credit markets. As active managers working with high degrees of freedom, we believe greater latitude grants us the ability to find better risk-adjusted return potential. Our goal is to manage a differentiated, high-conviction credit portfolio—aiming to take advantage of these degrees of freedom to create a unique return profile—which is why we build the portfolio without regard to an index. As career investors in the non-investment grade credit markets, we believe building a portfolio with an attractive overall risk-adjusted return profile is key to long-term success.
As such, we tier our portfolio into three categories. This allows us to be selective and precise in the risks we take. Allocations to each category vary over time based on market conditions, but are generally the consequence of bottomup credit selection, rather than top-down portfolio management. â– Core: 20%-60% Core investments are positions we view as having stable to improving credit profiles and lower loan to value ratios.
Core investments represent our stable foundation of income—holdings which have higher credit quality and less volatility, relatively speaking. â– Spread Tightening: 10%-50% Spread investments are those where we have an out-of-consensus view about a company’s credit improvement potential. We think these investments have significant upside potential which the We are attracted to companies with resilient business models and strong competitive positioning that we believe will show profit improvement and deleveraging. . broader market is mispricing. We look for scenarios where the potential for financial deleveraging can result in improved credit fundamentals, leading to spread tightening. These investments have unique, idiosyncratic risk profiles. Portfolio Construction The team generally determines the amount of assets invested in each issuer based on conviction, valuation and availability of supply. Based on the team’s analysis it divides the portfolio into three parts.
Core investments are generally positions with stable to improving credit profiles and lower loan to value ratios. Spread investments are those where the team has an out-of-consensus view about a company’s credit improvement potential. Opportunistic investments are driven by market dislocations that have created a unique investment opportunity. Allocations to each group will vary over time based on market conditions. â– Opportunistic: 10%-30% Opportunistic investments are driven by market dislocations that have created a unique investment opportunity. These selective opportunities can be driven by technicals in the loan and bond markets, where a short-term tactical scenario creates pricing dislocations.
This category can also be a home for company-specific catalyst-driven ideas. If we are comfortable with an underlying credit and think a meaningful catalyst is on the horizon, we may establish an opportunistic position. Position Size Position sizes are based on a combination of conviction, valuation and availability of supply. We want our best ideas to have the greatest impact in the portfolio, valuation and supply permitting. Some non-investment grade securities are small in size and trade infrequently, limiting our ability to build a meaningful position. Liquidity factors into our portfolio construction process as well.
The portfolio’s liquidity is monitored on a regular basis. From time to time, we will hold securities deemed to be illiquid. Any illiquid securities in the portfolio are a result of our fundamental investment process and are subject to the deep fundamental credit analysis that we perform. Sell Discipline Our sell discipline is straightforward: if there is a change in company fundamentals and/or there are better opportunities based on relative value for the level of risk, we will sell. Changes to company fundamentals may include scenarios in which a business is not performing as underwritten from a financial perspective or a business makes a change that is contrary to its stated strategic direction.
These situations can arise when the competitive environment changes, or when a company’s growth or profits fail to meet our expectations. We will also sell if a business is not broadly fulfilling its promises, for example, not paying down its debt or doing more acquisitions than anticipated. Relative value is another component of our sell discipline, and is the most common reason for exiting a position. We will exit a position if relative value is more attractive in a different debt instrument along the issuer’s capital structure or if we think market opportunities are better elsewhere. A Differentiated Approach Capital Structure Flexibility to invest across the debt capital structure in both high yield bonds and bank loans, as dictated by relative value Ratings Agnostic A philosophy that is ratings-aware but agnostic, resulting in atypical and idiosyncratic sector exposure Business Quality An adherence to business quality as a primary driver of value, without compromising for yield. Identifying Value A preference to act as a cash flow lender at par and asset-backed lender in times of market, sector or company-specific stress High Conviction A high-conviction portfolio built upon deep, fundamental analysis and thoughtful credit selection .
Carefully consider the Fund’s investment objective, risks and charges and expenses. This and other important information is contained in the Fund’s prospectus and summary prospectus, which can be obtained by calling 888.454.1770. Read carefully before investing. Fixed income securities carry interest rate risk and credit risk for both the issuer and counterparty and investors may lose principal value. In general, when interest rates rise, ï¬xed income values fall.
High income securities (junk bonds) are speculative, experience greater price volatility and have a higher degree of credit and liquidity risk than bonds with a higher credit rating. The portfolio typically invests a signiï¬cant portion of its assets in lower-rated high income securities (e.g., CCC). Loans carry risks including insolvency of the borrower, lending bank or other intermediary.
Loans may be secured, unsecured, or not fully collateralized, trade infrequently, experience delayed settlement, and subject to resale restrictions. Private placement and restricted securities may not be easily sold due to resale restrictions and are more difficult to value. The use of derivatives in a portfolio may create investment leverage and increase the likelihood of volatility and risk of loss in excess of the amount invested. International investments involve special risks, including currency fluctuation, lower liquidity, different accounting methods and economic and political systems, and higher transaction costs.
These risks typically are greater in emerging markets. Non-Investment Grade refers to ï¬xed income securities with lower credit quality. Leveraged Loans are extended to companies or individuals that already have considerable amounts of debt. Duration is measure of the sensitivity of the price (the value of principal) of a ï¬xed-income investment to a change in interest rates.
Enterprise Value is a measure of a company’s value. Upside Capture is statistical measure of an investment manager’s overall performance in up-markets. Margin of Safety is the difference between the market price and the estimated intrinsic value of a business.
The concept was developed by Benjamin Graham and is believed to be an important measure of risk and appreciation potential. A large margin of safety helps guard against permanent capital loss and improves the probability of capital appreciation; however, a margin of safety does not prevent market loss. All investments contain risk and may lose value.
Free Cash Flow is a measure of ï¬nancial performance calculated as operating cash flow minus capital expenditures. Financial Covenants are agreed upon conditions that must be met to fulï¬ll a loan agreement. Porter’s Five Forces model is used to develop an industry assessment for a company.
This framework evaluates the structure of the company’s industry by considering the nature of the competition, the balance of power between the company and its suppliers and customers and the elasticity of demand for the company’s product versus substitutes. Each element is scored on a ï¬ve-point scale (the higher being the better). Adapted with the permission of The Free Press, a Division of Simon & Schuster Adult Publishing Group, from COMPETITIVE ADVANTAGE: Creating and Sustaining Superior Performance by Michael E.
Porter. Copyright ©1985, 1998 by Michael E. Porter.
All rights reserved. Artisan Partners Funds offered through Artisan Partners Distributors LLC (APDLLC), member FINRA. APDLLC is a wholly owned broker/dealer subsidiary of Artisan Partners Holdings LP. Artisan Partners Limited Partnership, an investment advisory ï¬rm and advisor to Artisan Partners Funds, is wholly owned by Artisan Partners Holdings LP. © 2017 Artisan Partners.
All rights reserved. Not FDIC Insured | No Bank Guarantee | May Lose Value For Financial Advisor Use Only. Not for Distribution to the Public. 1/6/17 – A16741L-vIS Credit_PhilosProcess_vIS . Artisan Partners Funds Investor Share Class Institutional Artisan Global Opportunities Fund Artisan Mid Cap Fund Artisan Small Cap Fund ARTRX ARTMX ARTSX APHRX APHMX APHSX Artisan Global Equity Fund Artisan International Fund Artisan International Small Cap Fund ARTHX ARTIX ARTJX APHHX APHIX APHJX APDIX Artisan Value Fund Artisan Mid Cap Value Fund ARTLX ARTQX APHLX APHQX APDLX APDQX Global Value Team Artisan Global Value Fund Artisan International Value Fund ARTGX ARTKX APHGX APHKX APDGX APDKX Emerging Markets Team Artisan Emerging Markets Fund ARTZX APHEX Artisan High Income Fund ARTFX APHFX APDFX Artisan Developing World Fund ARTYX APHYX APDYX Growth Team Global Equity Team U.S. Value Team Credit Team Developing World Team Visit: www.ArtisanPartners.com Advisor APDRX APDMX .
Krug, CFA Portfolio Manager Scott J. Duba, CFA Scott P. Baker 30 W West (-) Our team was built from scratch to best 0 our investment philosophy suit and process. 90 Artisan Partners Credit Team Our Investment Team Our investment team has been built with one simple goal—to bring together a group of experienced investment professionals who excel at performing deep, fundamental credit work.
Our team, headed by a portfolio manager, is supported by analysts and a trader dedicated solely to one investment philosophy and process. While the process is a collaborative effort that allows the team to leverage internal resources and expertise, final decision-making ability lies with Bryan Krug, the Portfolio Manager. Together with Bryan, the analysts, as members of the research team, perform bottom-up credit analysis. As a small and nimble team, we maintain a generalist approach to research with sector tendencies.
We believe our broader perspective is beneficial—avoiding strict sector designations helps eliminate blind spots and missed opportunities. In addition to conducting his own research on certain names, Bryan is responsible for portfolio management and allocation. Our Investment Philosophy We have developed foundational beliefs about the non-investment grade credit market as a result of our many years investing in the asset class. Honed over up and down markets, these tenets form the core of our investment philosophy. First, we believe that the non-investment grade market has cyclical, industry and company-specific dislocations which we can exploit.
Cyclical dislocations are typically driven by the credit cycle. Industry dislocations stem from the profit cycle of a specific industry. Company-specific Artisan Partners Credit Team—Investment Philosophy and Process dislocations are those in which we have an out-of-consensus view about a company’s trajectory from which we believe we can profit. Second, we believe we can find the best risk-adjusted return opportunities through fundamental credit analysis and value identification across the capital structure.
We believe the market is innately complex and securities are frequently mispriced, which benefits investors who are willing to perform detailed, bottom-up analysis. Finally, we believe attractive risk-adjusted returns can be achieved over a full credit cycle with a repeatable, high-conviction investment process. We are not looking to achieve index-like returns. Our goal is to use the investment freedom we have to build a focused portfolio of non-investment grade securities that have the potential to add value over the long term. Our Investment Process Our goal is to invest in issuers with high-quality business models that have compelling risk-adjusted return characteristics.
As active managers with high degrees of freedom, we believe the disciplined execution of our process will enable us to build a portfolio of securities that can perform well regardless of the market environment. Idea Generation The first step of our investment process is idea generation. Our area of focus is the non-investment grade credit market, comprised primarily of high yield bonds and leveraged loans. We believe it is a deep market with an ample opportunity set. .
We are not geographically constrained, but our expertise and experience built over the years has led us to focus primarily on US-based issuers. Occasionally there are attractive investments outside of the US, most commonly in Europe. Idea Generation Quantitative Screens Qualitative Factors BUSINESS EVALUATION Fundamental Credit Research Business Quality Financial Strength & Flexibility Downside Analysis Value Identiï¬cation RELATIVE VALUE Portfolio Construction Core 20%-60% Spread Tightening 10%-50% Opportunistic 10%-30% One source of ideas is our customized quantitative screens that pull a variety of index constituent data on a daily basis. We use the screens as a mechanism to narrow down the investment universe, which includes over 1,500 issuers in the bond and loan markets, taking into consideration that some issuers offer bonds and loans. Screens are based on characteristics such as yield, performance and relative value across and within sectors.
If any security, grouping or pattern stands out to us, we will take a closer look. Non-quantitative methods are also employed for idea generation, including monitoring credit trends and attending industry conferences. We also draw on our network of buy-side, sell-side and private equity relationships. The primary market, in which banks facilitate new transactions between borrowers and lenders, is a natural source for new ideas. We are selective when it comes to participating in primary transactions. The deals brought to market by non-investment grade issuers may feature complicated corporate and capital structures and unique covenant packages.
Each financing is unique. Doing a thorough, detailed review on the credit as a whole and the transaction in particular is always necessary. Though some may think the primary market is a convenient source of supply, we think investors who breeze through the details are often those who end up on the wrong side of the risk-reward equation. Idea generation is the starting point of our process.
The result is a list of investment candidates that we dive into deeper during the most crucial step of our process—fundamental credit analysis. This is where we spend most of our time and what ultimately drives our outcomes. Fundamental Credit Analysis Fundamental credit analysis is the core of our investment process. It requires passion and dedication plus a significant amount of time and effort, but we believe this is where we add the most value. We rely primarily on self-generated research.
To enhance and amplify our own proprietary models, we make use of external resources. As a matter of course, the investment process generally includes conversations with company management, industry experts and competitors and we will, from time to time, engage consultants with industry expertise to provide detailed information specific to individual investment ideas. We believe that accessing third party resources and expert networks helps to build a complete understanding of the company, its management and its capital structure.
We also draw on our network of buy-side, sell-side and private equity relationships throughout the process. Furthermore, we do extensive document review (again, with a third party’s assistance) to ensure comprehensive understanding of the debt capitalization, covenants, etc. We believe cohesion and dedication to a unified philosophy and process are necessary ingredients for successful investing. As such, daily communication and collaboration are key ingredients to our overall process.
We usually gather as a team twice daily. During our regular morning meeting, we cover market color, the new issuance calendar as well as activity and movers in the secondary market. We also broadly communicate what we are focused on that day. As active managers with high degrees of freedom, we believe the disciplined execution of our process will enable us to build a portfolio of securities that can perform well regardless of the market environment. .
Our daily lunch meeting is more in-depth. This provides the team a forum for comprehensive discussions about our current credit work, research findings and investment ideas. Team members present ideas and field questions within an active dialogue. We believe that this collegial approach provides us with relative value perspective across sectors, and prevents us from becoming too blinkered with regard to our own areas of focus.
Detailed research notes and financial models are maintained within our internal research platform. Ad hoc discussions occur on a regular basis in our Kansas City office, typically when there is a company-specific news item or research updates to existing or potential holdings. In addition, each position in the portfolio also undergoes an in-depth quarterly re-underwriting process. Meetings are held with each of the analysts individually to rigorously evaluate all owned names, taking into account any recent corporate developments, company earnings and current market conditions.
By doing so, we can determine if the investment thesis holds true and/or other current opportunities are now more compelling. The team’s analysts spend the vast majority of their time on research, while our trader is responsible for executing on trade decisions made by the portfolio manager. Our trader works very closely with the team’s investment professionals to ensure ongoing information is shared, including news related to portfolio companies, planned changes in the portfolio, and market and trade activities/ developments. We consider trading to be a value-added process. Our analysis is based on four pillars: â– Business Quality A variety of sources are used to understand the resiliency of an issuer’s business model.
We analyze the general health of the industry in which an issuer operates, the issuer’s competitive position, the dynamics of industry participants and the decision-making history of the issuer’s management team. Fundamental Credit Analysis In the non-investment grade credit market, we are attracted to companies with resilient business models and strong competitive positioning which we believe will show profit improvement and financial deleveraging. Businesses with recurring revenue and low capital intensity are appealing as they tend to have predictable revenue streams. Our analysis is based on four pillars: â– Business Quality â– Financial Strength and Flexibility â– Downside Analysis â– Value Identification Porter’s Five Forces Analysis is utilized to understand the competitive position of a business. This tool gives us a framework to assess a company’s buyers, suppliers, competitive rivalry, the threat of new entrants and the threat of substitutes. â– Financial Strength and Flexibility Every capital structure in the non-investment grade market is constructed uniquely and some can be complex.
Generally, we embrace complexity. A lot of investors shy away from the work, but we appreciate the prospect of unearthing opportunities by committing time to do the research. This level of analysis allows us to participate in what we deem to be the optimal risk-adjusted portion of a company’s capital structure. Analyzing the history and trend of free cash flow generation is critical to understanding an issuer’s financial health in this process.
The financial analysis also considers an issuer’s capital structure, refinancing options, financial covenants, amortization schedules and overall financial transparency. Some of the ratios evaluated include free cash flow to debt and debt to implied enterprise value. We will further evaluate two-year deleveraging at various points within a capital structure. This process leads to a portfolio of businesses with potentially strong and improving free cash flow to debt. â– Downside Analysis We believe that credit instruments by their nature have an asymmetric risk profile—the risk of loss is often greater than the potential for gain, particularly when looking at non-investment grade issuers.
As debt holders, we have to focus on what can go wrong. We seek to mitigate this risk with conservative financial projections that account for industry position, competitive dynamics and positioning within the capital structure. There is also an avoidance of companies we believe are overrated or have the potential for credit deterioration. Artisan Partners Credit Team—Investment Philosophy and Process .
We have an unwavering focus on risk-adjusted return potential and upside capture. We believe that margins of safety should not be compromised in the search for yield. When we examine valuations, our goal is to be default agnostic. This means we want to be confident the enterprise value is sufficient to support a return of our invested capital in a default.
This discipline is intended to prevent permanent capital impairment in times of stress. â– Value Identification Multiple metrics are used to determine the value of an investment opportunity. We look for credit improvement potential, relative value within an issuer’s capital structure, catalysts for business improvement and potential value stemming from market or industry dislocations. We are capital-structure agnostic: we pick our spot along the capital structure based on relative value. The portfolio’s split between bonds and loans will always be the result of our bottom-up security selection process.
We think this flexibility to invest along the capital structure is a key differentiator for our strategy. How We Think About Credit Ratings For better or worse, most players in the non-investment grade credit market have credit ratings (as assigned by agencies like Moody’s, S&P or Fitch) on their radar. We describe our investment process as “ratings-aware.” However, investment decisions are made based on fundamental research to determine the creditworthiness of a given company. As a result, we will oftentimes be attracted to businesses that we believe are underrated.
The difference can be partly attributed to divergent views on recovery: the major ratings agencies, in our view, tend to overemphasize hard assets and underemphasize cash flow generated by assets such as intellectual property. In essence, we take on the responsibility for assessing credit risk, rather than abdicating it to the rating agencies. Duration and Other Portfolio Considerations We believe the non-investment grade credit market’s largest sensitivity is to the collective credit environment, not interest rates. As such, duration risk will always be secondary to credit risk for us. Our focus is to manage company-specific risk.
We take on market risk when we make an investment, but above all we try to find opportunities where we can profit from credit improvement. While not required, we usually seek to hedge against the risk of loss resulting from currency fluctuation. We generally do not trade Treasury notes as a means to hedge our interest rate risk. Portfolio Construction We believe individual security selection is the best way to take advantage of the potential opportunities presented by inherently complex and inefficient non-investment grade credit markets. As active managers working with high degrees of freedom, we believe greater latitude grants us the ability to find better risk-adjusted return potential. Our goal is to manage a differentiated, high-conviction credit portfolio—aiming to take advantage of these degrees of freedom to create a unique return profile—which is why we build the portfolio without regard to an index. As career investors in the non-investment grade credit markets, we believe building a portfolio with an attractive overall risk-adjusted return profile is key to long-term success.
As such, we tier our portfolio into three categories. This allows us to be selective and precise in the risks we take. Allocations to each category vary over time based on market conditions, but are generally the consequence of bottomup credit selection, rather than top-down portfolio management. â– Core: 20%-60% Core investments are positions we view as having stable to improving credit profiles and lower loan to value ratios.
Core investments represent our stable foundation of income—holdings which have higher credit quality and less volatility, relatively speaking. â– Spread Tightening: 10%-50% Spread investments are those where we have an out-of-consensus view about a company’s credit improvement potential. We think these investments have significant upside potential which the We are attracted to companies with resilient business models and strong competitive positioning that we believe will show profit improvement and deleveraging. . broader market is mispricing. We look for scenarios where the potential for financial deleveraging can result in improved credit fundamentals, leading to spread tightening. These investments have unique, idiosyncratic risk profiles. Portfolio Construction The team generally determines the amount of assets invested in each issuer based on conviction, valuation and availability of supply. Based on the team’s analysis it divides the portfolio into three parts.
Core investments are generally positions with stable to improving credit profiles and lower loan to value ratios. Spread investments are those where the team has an out-of-consensus view about a company’s credit improvement potential. Opportunistic investments are driven by market dislocations that have created a unique investment opportunity. Allocations to each group will vary over time based on market conditions. â– Opportunistic: 10%-30% Opportunistic investments are driven by market dislocations that have created a unique investment opportunity. These selective opportunities can be driven by technicals in the loan and bond markets, where a short-term tactical scenario creates pricing dislocations.
This category can also be a home for company-specific catalyst-driven ideas. If we are comfortable with an underlying credit and think a meaningful catalyst is on the horizon, we may establish an opportunistic position. Position Size Position sizes are based on a combination of conviction, valuation and availability of supply. We want our best ideas to have the greatest impact in the portfolio, valuation and supply permitting. Some non-investment grade securities are small in size and trade infrequently, limiting our ability to build a meaningful position. Liquidity factors into our portfolio construction process as well.
The portfolio’s liquidity is monitored on a regular basis. From time to time, we will hold securities deemed to be illiquid. Any illiquid securities in the portfolio are a result of our fundamental investment process and are subject to the deep fundamental credit analysis that we perform. Sell Discipline Our sell discipline is straightforward: if there is a change in company fundamentals and/or there are better opportunities based on relative value for the level of risk, we will sell. Changes to company fundamentals may include scenarios in which a business is not performing as underwritten from a financial perspective or a business makes a change that is contrary to its stated strategic direction.
These situations can arise when the competitive environment changes, or when a company’s growth or profits fail to meet our expectations. We will also sell if a business is not broadly fulfilling its promises, for example, not paying down its debt or doing more acquisitions than anticipated. Relative value is another component of our sell discipline, and is the most common reason for exiting a position. We will exit a position if relative value is more attractive in a different debt instrument along the issuer’s capital structure or if we think market opportunities are better elsewhere. A Differentiated Approach Capital Structure Flexibility to invest across the debt capital structure in both high yield bonds and bank loans, as dictated by relative value Ratings Agnostic A philosophy that is ratings-aware but agnostic, resulting in atypical and idiosyncratic sector exposure Business Quality An adherence to business quality as a primary driver of value, without compromising for yield. Identifying Value A preference to act as a cash flow lender at par and asset-backed lender in times of market, sector or company-specific stress High Conviction A high-conviction portfolio built upon deep, fundamental analysis and thoughtful credit selection .
Carefully consider the Fund’s investment objective, risks and charges and expenses. This and other important information is contained in the Fund’s prospectus and summary prospectus, which can be obtained by calling 888.454.1770. Read carefully before investing. Fixed income securities carry interest rate risk and credit risk for both the issuer and counterparty and investors may lose principal value. In general, when interest rates rise, ï¬xed income values fall.
High income securities (junk bonds) are speculative, experience greater price volatility and have a higher degree of credit and liquidity risk than bonds with a higher credit rating. The portfolio typically invests a signiï¬cant portion of its assets in lower-rated high income securities (e.g., CCC). Loans carry risks including insolvency of the borrower, lending bank or other intermediary.
Loans may be secured, unsecured, or not fully collateralized, trade infrequently, experience delayed settlement, and subject to resale restrictions. Private placement and restricted securities may not be easily sold due to resale restrictions and are more difficult to value. The use of derivatives in a portfolio may create investment leverage and increase the likelihood of volatility and risk of loss in excess of the amount invested. International investments involve special risks, including currency fluctuation, lower liquidity, different accounting methods and economic and political systems, and higher transaction costs.
These risks typically are greater in emerging markets. Non-Investment Grade refers to ï¬xed income securities with lower credit quality. Leveraged Loans are extended to companies or individuals that already have considerable amounts of debt. Duration is measure of the sensitivity of the price (the value of principal) of a ï¬xed-income investment to a change in interest rates.
Enterprise Value is a measure of a company’s value. Upside Capture is statistical measure of an investment manager’s overall performance in up-markets. Margin of Safety is the difference between the market price and the estimated intrinsic value of a business.
The concept was developed by Benjamin Graham and is believed to be an important measure of risk and appreciation potential. A large margin of safety helps guard against permanent capital loss and improves the probability of capital appreciation; however, a margin of safety does not prevent market loss. All investments contain risk and may lose value.
Free Cash Flow is a measure of ï¬nancial performance calculated as operating cash flow minus capital expenditures. Financial Covenants are agreed upon conditions that must be met to fulï¬ll a loan agreement. Porter’s Five Forces model is used to develop an industry assessment for a company.
This framework evaluates the structure of the company’s industry by considering the nature of the competition, the balance of power between the company and its suppliers and customers and the elasticity of demand for the company’s product versus substitutes. Each element is scored on a ï¬ve-point scale (the higher being the better). Adapted with the permission of The Free Press, a Division of Simon & Schuster Adult Publishing Group, from COMPETITIVE ADVANTAGE: Creating and Sustaining Superior Performance by Michael E.
Porter. Copyright ©1985, 1998 by Michael E. Porter.
All rights reserved. Artisan Partners Funds offered through Artisan Partners Distributors LLC (APDLLC), member FINRA. APDLLC is a wholly owned broker/dealer subsidiary of Artisan Partners Holdings LP. Artisan Partners Limited Partnership, an investment advisory ï¬rm and advisor to Artisan Partners Funds, is wholly owned by Artisan Partners Holdings LP. © 2017 Artisan Partners.
All rights reserved. Not FDIC Insured | No Bank Guarantee | May Lose Value For Financial Advisor Use Only. Not for Distribution to the Public. 1/6/17 – A16741L-vIS Credit_PhilosProcess_vIS . Artisan Partners Funds Investor Share Class Institutional Artisan Global Opportunities Fund Artisan Mid Cap Fund Artisan Small Cap Fund ARTRX ARTMX ARTSX APHRX APHMX APHSX Artisan Global Equity Fund Artisan International Fund Artisan International Small Cap Fund ARTHX ARTIX ARTJX APHHX APHIX APHJX APDIX Artisan Value Fund Artisan Mid Cap Value Fund ARTLX ARTQX APHLX APHQX APDLX APDQX Global Value Team Artisan Global Value Fund Artisan International Value Fund ARTGX ARTKX APHGX APHKX APDGX APDKX Emerging Markets Team Artisan Emerging Markets Fund ARTZX APHEX Artisan High Income Fund ARTFX APHFX APDFX Artisan Developing World Fund ARTYX APHYX APDYX Growth Team Global Equity Team U.S. Value Team Credit Team Developing World Team Visit: www.ArtisanPartners.com Advisor APDRX APDMX .
