Aegis Funds - High Yield Commentary

A few months ago, we featured the team from the Aegis Funds in our emerging manager interview series. The team is out with their Quarterly Letter (embedded below), and as usual, it's fantastic. Here are some of my takeaways:

• The Aegis High Yield Fund outperformed by 100 bps for the quarter. This might not seem remarkable, except when you realize their duration is 2.7 versus 4.6 for the Barclays HY Very Liquid Index
• Great quote: "Currently, the Federal Reserve is in the process of completing a renewed $600 billion program of debt monetization through money printing, known as QE2, which has now resulted in a near tripling of the monetary base since early 2009. The enormous surge in liquidity from this questionable economic policy has forced short-term interest rates to extraordinarily low levels, driving all manners of investors into risk assets to avoid the painful, slow erosion of purchasing power when holding cash or treasury bills with yields under the rate of inflation. In this low-rate environment, high yield bonds have certainly proven to be a popular asset class with investors. The first quarter of 2011 was no exception, with Credit Suisse estimating high yield fund flows of $5.4 billion."
• Aegis believes the amount of excess reserves held at the Fed will ultimately result in inflation if bank turn the lending spigot on
• Fantastic quote on Washington (a point I 100% agree on): "While the Federal Government continues on track to spend more than $1.5 trillion more than it receives this year, politicians recently declared a shutdown-averting victory with a $38 billion “compromise” cut in the $3.8 trillion federal budget. While the Washington Post hailed the “Biggest Cuts in U.S. History,” anyone with basic math proficiency can understand the intellectual incoherence of touting a one percent cut in a federal budget in this fashion, particularly given that the federal budget has increased by an incredible 40 percent since 2007. The current level of government spending is clearly unsustainable."
• Letter notes the recent move up in pricing for basically everything and the Fed's lackluster response
• Another point I 100% agree on - and probably worth of a future post: " Government inflation statistics themselves are also suspect, having been subject over the years to changes in calculation methodology, which now include modifications such as hedonic adjustments and substitution effects, all of which appear to moderate the reported rate of inflation. Reported inflation would have hit an annual rate of 9.6 percent in February, had the reporting methodologies remained consistent with those in place prior to 1980, according to the Shadow Government Statistics newsletter."
• The aforementioned points are the reason why the fund has kept its duration so low
• In addition to keeping duration low they are buying floating instruments, buying underlying investments that will benefit in a raising rate environment, buying foreign corporates and converts
• Favorite quote, and one of the reasons I have been putting less and less money to work: "When credit spreads are low and the yield curve steep with short term rates near zero, fixed income funds have increased incentive to borrow money at ultra-low short rates to finance longer-duration bond purchases to “enhance” yield. In this context, it is somewhat disconcerting to note that reported margin debt has now increased to $310 billion in February, up a significant 7.2 percent from January and well up from its $200 billion post-crash low in early 2009.
• Largest Purchase for the fund: Reddy Ice 11.25% of 2015
• Playing higher up in the cap structure: 71% of fund in Senior Secured issues or unsecured bonds with nothing ahead of them in the cap structure

For more information about the Aegis High Yield Fund, please visit: "http://www.aegisfunds.com/highyieldfund/"

Ahyfx q12011 Letter