Is High Yield Expensive Near Its Tights? | Marty Fridson (Lehmann Livian Fridson Advisors) #24

It's a wrong to say that the market is cheap simply because the spread is wider than its historical average. The spread is a risk premium double B single B spread widened up by 45 basis points. You would have expected the triple C and lower spread to widen by just a little over 100 basis points, but instead the triple C and lower spread widened by almost 250 basis points. Welcome to another episode of Fixing Floating. Yours high yield is currently sending very mixed signals. Index spreads are trading close to their tides. While beneath the surface, lower quality credits have been underperforming. Triple C spreads are close to 1100 basis points and the gap to double B's is the wider since 2020. Today we'll explore when high yield is truly mispriced and whether it is now we'll also dig into why triple C credits have moved so far out of line with the broader market and whether most compelling pockets of undervaluation are today. I'm very pleased to welcome Marty Fritzon. Marty ran Hyde's strategy at Merrill Lynch for 13 years and wrote one of the first books on high yield investing back in 1989. He's now CIO at Lehman, Livy and Fritzon Advisors. Marty, welcome to the show. Well, great to be here with you. Marty, would you mind if you listen as a bit of background on your experience? Absolutely. I started out as a corporate bond trader now 50 years ago in 1976 and I then moved into credit research and got a CFA charter. Now the high yield market was starting to take off in the early 1980s and that created a need for serious objective research rather than just the standard promotion of Wall Street finding a lucrative new business and wanting investors to get involved in it. So I eventually headed research groups at Morgan Stanley and at Merrill Lynch and along the way I served as president of the Fixed Income Analyst Society and also as a director of the CFA Institute. Later on I moved to the by side at Lehman, Livy and Fritzon Advisors. We run separately managed accounts consisting of a wide variety of income investments with high yield bond ETFs representing just a small portion of that. My contributions to the field were recognized by my election to the Fixed Income Analyst Hall of Fame and for many years I've served as book review editor for the CFA Institute. That sounds very, very impressive so it sounds to me that you are kind of the Scotty Pippen of high yield research. In our free quality of said that much of what has been written by others about the history of the high yield market is wrong. Could you give us some examples? Absolutely. The myth that was heard as the market was just getting going was that the high yield universe consisted entirely of fallen angels. In other words these are bonds that were rated investment grade triple B or higher when they originally came to market but were later downgraded below investment grade and supposedly there was no issuance of anything with less than a triple B rating before Michael Milken and Drexel Burnham Lambert started doing that in 1976. They were not by the way the first firm to do that in 1976. There were a small number of new issues each year during the 1970s and when the new issue market got going interestingly Milken seemed to be interested mainly in refinancing distressed companies. The rising star idea this was small companies that didn't qualify for investment grade ratings but could now issue bonds in the public market. That was really the idea of Felon and Marty Berman who had a lot of contacts with many of those small companies from his work in the financial markets prior to getting involved in the high yield business of Drexel. The leverage by out business financing of albios was really the idea of Leon Black who was in the investment banking department at Drexel at the time. Another myth and I think really verges into propaganda was that Drexel's effort was democratizing capital as they put it. In other words there were companies that because they were small out of favor in industries that weren't considered respectable such as casinos or maybe there were leaders of those companies that were from minority groups they were unable to get capital completely blocked out. Well the reality is that those companies I found consistently when I studied that question they had in the years before they began issuing high yield bonds. They raised money in the private placement market so they were not denied access to capital but the attraction of high yield was they didn't have any covenants in the early days. That changed over time but there were no meaningful covenants on the early high yield deal so of course that was much more attractive to the issuers not as good a deal for the investors as the investors found out. Even the term high yield supposedly was unknown before Drexel invented it but the reality is that John Moody from the bond rating service was using that term as at least as early as 1919 positively earlier than that. I think it was independently coined at Drexel they weren't aware of Moody and having used it and later the researcher Harold Frayne using the term high yield bonds in the 1930s but it was not known this was entirely new. So you just touched upon fallen angels the claim that they should offer superior returns as they need to be sold upon downgrade to high yield you are saying that this assumption is essentially not true. Yeah it was of course one of the number of things made up by traders or salesmen to get trades done and it sounded obvious and logical but the idea was that oh yeah as soon as the bond gets downgraded to blow investment grade the institutional holders are forced to sell immediately and so in this fire sale situation the fallen angels automatically become undervalued and of course they recover and you earn consistently superior returns in those bonds. Well that was a myth I found that there was no unusual risk-adjusted return on fallen angels some of them got worse they continued until they became defaults continued deteriorating some rebounded some eventually returned to investment grade but there was no systematic undervaluation and one of the factors in that was that I called up the three largest pension plan sponsors in the United States and I asked them what their actual policy was if a whole if they had a manager of investment grade corporate bonds who owned a bond that got downgraded to double B what would happen then and they said oh well the last thing we would want them to do would be to sell it immediately when everyone else is trying to sell it and get less than the fair value for that fallen angel bond so we say yes because you have a mandate to run investment grade bonds you should discard that high yield bond but you know take your time to do it sell when the market is in a good condition and that was the answer throughout so it really was one of a number of things what when I started got involved in heading the research group at Morgan Stanley I had to start looking beyond individual company analysis at more general topics and so I started with everything I had learned as a trader and said yeah I wonder if anyone has ever actually tested any of these supposed you know I call it market lore but these supposed truisms about how the market operated and I consistently found that no they were just made up and convenient things there was no empirical support for any of those things are there any other bro signs cases which you discovered after you became an analyst? Yeah, there was this idea that I heard was what was that, if a company cuts its dividend on its common stock, that's good for the bondholders, because that means there's more cash available to pay for the interest on the bonds. I thought, well, you know, that sounds logical in one sense, but on the other hand, companies don't like to cut their dividends, you know, the CEOs of these companies are often large shareholders themselves, so do they really want to give themselves a pay cut by cutting the dividends on the stock that they own? So I said, well, let's find out, it's worth a test, and there again, I found that there was no tendency for the bonds to improve to be perceived as better credits because they cut the dividend. In fact, quite the opposite, what it appeared to be was that the companies delayed longer than they should have in cutting the dividend, so when they finally did, the market recognized that they were in somewhat strained conditions, and the bonds actually traded down. I think in our pre-code, we already talked a bit about how the composition of the Hyde Index has changed dramatically over time. Could you tell listeners a bit more how the index looked like at the beginning of the Hyde market than evolved throughout the early 2000s, then changed again after the great financial crisis, and how it looks like today? Sure. Well, as you can imagine, when the new issuance was really just getting started, it was in the context of a market that was mostly, not 100 percent, but mostly fallen angels at that time. So that was a big part of the index. Nowadays, it's just 4 percent because there has been so much original issue, Hyde bond issuance that's come to market in the intervening years. It took a while before you were able to issue new bonds with ratings as low as triple C. Those were considered investors thought of those bonds as having one foot in the grave. So in the early years, let's say in the early to mid 1980s, you didn't have a lot of bonds still rated triple C unless they had deteriorated to that point, already possibly having been fallen angels. Now, it's a little hard to get too specific on this because the Icebe of A U S Hyde Index, which is the one that I operate with primarily, it was not digitized until 1996. But in January of 1997, bonds rated triple C or lower accounted for 16 percent of the total face amount of the index. That is now down to just under 10 percent. And at that time in January of 1997, about 30 years ago now, only 12.5 percent of the face amount was secured debt. A lot of that being debt issued by utilities. Now that has spread more widely and it's 36 percent of the total face value is accounted for by secured bonds, which is quite a dramatic change. When did this change to secured bonds occur? Was it gradual over time? Or was there a point of time that just started to increase? Yeah, it grew somewhat over time, but there's been a very significant shift over just the last 10 years. And I attribute some of that to the intensified competition for financing by below investment grade companies from both a leverage loan market and more recently the private credit market, where it is typical to have secured debt. And as a result of that, the investors in the Hyal bonds want to be sure that they will not be junior to new debt that comes in, because particularly private credit, a lot of their -- that business is done specifically by finding loopholes in existing covenants that get enabled companies to issue debt that so-called priming the existing investors, the issue debts higher in the capital structure than they are. One of the things that the result of that in just the last few years is that we now see gradations companies with Hyal bonds that are called secured that used to be all you needed to say. That was going to put you at the top among the bondholders, but there are actually some examples of four different levels of secured bonds. So there have been quite an evolution in the relatively recent past. Yeah, I think you're touching on the increasing prevalence of liability management exercises. If you look about the long run average off of spreads, does this long run average also, let's say, the spread in the early 2000s, does this tell us anything about the credit quality and the risk profile of today's market? Well, it definitely creates a problem because you're talking about substantially different universe and particularly the greater concentration in secured debt lowers the risk of the index as a whole, combined with the reduced concentration in the triple C's and increased concentration in the double B's at the top of the quality spectrum within investment grade. But even aside from that, it's wrong to say that the market is cheap simply because the spread is wider than its historical average. The spread is a risk premium. So if the risk in financial markets is greater than average, the spread should be greater than average. It doesn't demonstrate that the market at that time is cheap. So you have to come up with a way to quantify the prevailing risk in order to make that kind of a judgment. If you like this episode, subscribe to Fixed and Floating. You won't miss anything and it really helps the show and now back to the conversation. If you would rebuild the 1989 or I think 1986 index on today's ratings mix, what would the average spread approximately be? Okay. Well, again, it's somewhat difficult to be too specific because the details of the index only exist on paper. So it would be very difficult to reconstruct that. I can tell you that since 2016, the average spread has been 392 basis points in the 10 years before that in average 580. And now that is not because economic conditions have gotten easier in the last 10 years, actually by testing some of the measures of risk in the environment, I found that if anything, risk has been greater in the more recent period. So the only way to explain why spreads have been narrower in recent years is that the quality mix of the high-owned universe has improved. Most analysts usually only look at the average of the index. You did create a multi-factor regression model. I think you just recreated a model for a new article. What did the old version miss and what did you add? Well, our main motivation, this was in conjunction with my colleague, Jack Beda. Our main motivation was taken to count the substantial change in the index's quality mix in recent years as I spoke about with the triple C and secured debt concentration. But in the process, we explored some new variables and we replaced one of them. So the new model brings in the Treasury yield curve, which has to do with liquidity in the high-owned market as well as the economic outlook. We brought in the current default rate. that the Office of Financial Researchers, Financial Stress Index? Which is the most important factor, which of the factors are doing most of the explanatory work in the model? Well, the credit availability is a very powerful explainer. As far as the recent changes, I believe the adding the variables to represent the percentages represented by triple C bonds and secured debt that is the percentage of the total face amount have represented the most important changes. Vice credit availability is so important. The financial condition of companies is highly dependent on their ability to not only raise capital for expansion, but also to refinance, maturing, now companies buy them. And large are run intelligently from that standpoint, and they will refinance debt maturities before the wolf is at the door, so to speak. So you typically don't see a large percentage of their debt maturing just within the next 12 months, but they also face the risk that they may have to refinance existing debt at higher levels and their ability to do that will be dependent on banks' willingness to lend and the standards that they set. Some of the lower quality companies may have to cross a very high bar in order to qualify. So it has proven to be an important factor in explaining the spread. And of course, if banks cut back on their financing, that could cause disruption in the economy itself, which again will cause spreads to widen on speculative grade bonds. Most of their value come out very differently than in the old model. It's not a radical change, but there have been periods where the implied investment action is different under the new model than it would have been under the old model. And beyond that, not every fixed income manager frequently changes the high-yield allocation in a general fixed income portfolio. But for those who have a trigger point, like, say, if there's a one standard deviation divergence between the actual spread and fair value, I will increase or decrease my high-yield allocation, according to which direction that divergence is in. There have been some specific points where the change in allocation would have occurred under the new model, but it would not have been made under the old model. There would not have been that larger discrepancy between the actual and fair value spread using the old model. And it would have been historically good times to invest in high-yield, and when was risk just adequately compensated for? Well, the spreads have usually reached their widest during recessions. That doesn't mean it's automatically a good time to jump in, because a lot depends on how long that recession is going to last. But you've had some very good opportunities as you get further along, I wouldn't say you can pinpoint it to the month, but in other words, that you'll do better the very next month after the modeling indicates that it's a good opportunity, but over a longer period in measuring quarters or, let's say over the course of the year, you'll have a good entry point there. But there are factors not as extreme as recessions that cause high-yield market to become cheap to the tune of one standard error, which is now 116 basis points, relative to the fair value, more related to supply demand conditions, just other types of factors that influence performance in the financial markets in general. To make things a bit more interesting for all listeners, where does the model put value at the moment? At the end of October, the model's fair value estimate was just 275 basis points. That's well below historical averages, but the factors in the model indicate that risk is at a fairly low point currently. So, with the actual spread at the end of October at 344 basis points, the high-yield market was somewhat undervalued, although not extremely so. What would a key drive is at the moment or what other key drive is? Well, you have fairly good credit availability. The banks are willing to lend. There have been some rumblings recently, even in some sectors, they may be being too easy. I wouldn't say it's an extremely easy money kind of market, but that's a very positive factor. The economy has been doing well, the economic indicators, including the treasury yield curve are fairly positive in that respect. So, investors are comfortable taking risk at this point, and we're not seeing pronounced financial stress in the markets at this point. Also, I should note that the treasury yield is inversely correlated with the spread. Another example is something that I was taught, the exact opposite and wrong lesson in my trading days and only learn later that, in fact, when treasury yields are high, the spread versus treasury tends to be lower and the rise in the treasury yield over the last several months has added to that contraction of the fair value spread to a fairly low point currently. What's the economic intuition between that negative correlation between treasury yields and spreads? Yeah, an excellent question, and I think that one of those is simply that if demand for capital is high, that's usually indication that corporations see good earnings prospects before they head, they want to expand, and that's why they're out borrowing in the capital markets, and that is going to push interest rates higher. There are several factors that influence that ten-year treasury yield. It's the five-year that we use in the model because that's closer to the average maturity of the bonds in the high-yield index, but this year, contrary to what you may have read, it really has not been rise in inflation expectations that has caused the medium and long-term treasury yields to rise, so it makes sense that the risk premium would be smaller if the economic outlook, and as a result, the demand for capital is high. One other factor is that, to some extent, particularly if you're managing liabilities such as the cost of life insurance policies that you've written, that what really matters is not so much to the spread but the absolute yield that you're getting on your bond investments. So those investors may be willing to accept a somewhat smaller premium if they are earning a higher yield on their high yield investments. So I think probably some combination of those factors accounts for what strikes a lot of people as a counter to a intuitive result. I think I actually had a professor of finance, a very smart individual one time in my office saying that it was impossible that obviously the spread had to be proportional to the yield on the underlying treasury bonds but empirically you'll find that's just not the case. You just stay with the first point for a moment so you just said yields are negatively correlated with spreads and that especially this year real rates have been the driver of nominal yields which points towards a very healthy economy high demand for capital. But I'm curious here because it seems that this is very positive for let's say productive use of capital whereas other investments such as in real estate or fiber or other uses they depend much more on lower real yield that really helps their business and their investment case. And those seem to be punished a bit more by the market at the moment. Is that also your interpretation or I'm getting too far? No no I think that's absolutely right I mean mortgage rates have had a terrible year. The value has been hit very hard that's not really something it's meaningfully represented in the high yield market so fortunately the most the industries are doing fine. And one thing to keep in mind is that if you read the media accounts it will often say well the market is headed for big fall because interest rates have gone up and borrowing costs are rising well that would be a real problem if companies were doing all their borrowing at adjustable rates in the short term market but that would not be very irresponsible from the standpoint of a chief financial officer to do that. So typically if a company has to go to market to add to its total debt outstanding yell it'll be paying a higher yield than it did a few years ago or even last year but that's going to be averaged into its overall cost of debt rather than pushing up the total borrowing cost by the full amount of the rise in real rates let's say since the beginning of the year. So over time the company has the ability to adjust possibly raising more equity capital to reduce the total amount of debt that it has to pay interest on getting some pricing relief from the market as those borrowing costs get passed along to customers ultimately to consumers so it's not the crisis that you often read about by reporters who understandably are looking to generate a lot of hits on their stories but it's not really an accurate portrayal of how it affects the income statements of the companies. If you're looking for more credit related content check out fixandfloating.com and now back to the show. Yeah very good point and the thing it brings us to our next part of the conversation triplesy and distressed I think they looked very cheap at the beginning of the year and now they underperformed massively I personally attribute it especially through a rising real rates why has in you of you underperformed triple C so massively and especially versus double B's and single B's. Yeah well when the high yield spread widens and it has very recently it's normal for the triple C and lower spread to widen more than double B and single B I look for some purposes look at that as a combined double B and single B spread which ICE indices publishes an index on that combines those two. Well based on the historical experience and for this discussion I'm not considering the starting points where the spreads were at the end of 2025 but since that time the combined double B single B spread widened up by 45 basis points and based on the historically based modeling of that you would have expected the triple C and lower spread to widen by just a little over 100 basis points but instead the triple C and lower spread widened by almost 250 basis points from that point. So this suggests that even though investors are accepting an overall higher spread that's considerably narrower than somewhat narrower than fair value at the moment they are very concerned about the possibility of a weakening of the economy even though the indicators aren't particularly pointing in that direction they are hedging their bets a bit and not taking the risk of getting hit in a big way by the weakest credit getting hurt by a softening of the economy so at this point the investors are skewing toward the medium to higher quality portion of the high yield market. You just mentioned that usually when the better quality or higher quality part of the high yield market is underperforming, triple Cs are underperforming even stronger. What is the mechanism that puts so much pressure on lower quality credits in a downward cycle? Well I triple C companies have a smaller cushion against an economic decline than double B or single B companies now if you have a drop in the economic outlook that means that corporate earnings and cash flows will decline now the interest coverage ratios will decline at the higher end speculative grade companies so their spreads will widen but they'll still cover their interest by a comfortable margin and they won't be at risk of a near term default but a decline in EBITDA will put a lot of triple C companies in the position of just barely covering their interest rate or possibly not fully covering it at all. So for those companies the risk of a near term default suddenly becomes very real and for this reason it's natural that their spreads will widen out more than the spreads on double Bs and single Bs which are still not at a high risk of default anytime soon. So you are saying that concern about debt sustainability is the key driver in these cases. Yeah, that's right. We talked earlier about fallen angels and I think you mentioned the concept of risk transfer that some people are forced to sell that creates opportunities for other investors. I think very recently we have seen article citing that Eurenia UK based hedge fund faced margin calls and had to sell some of their positions. Could you share a bit of light about the holder base in high yield and more towards the lower end of the credit spectrum and also the flows of these players and how this impacts the credit returns? Certainly many high yield bond funds either avoid or severely limit their exposure to triple Cs. They'll say well we might have a few if our analysts believe that those companies are underrated but we're really not players in that bottom tier of the market and they're even some funds that concentrate entirely on double Bs that is the highest quality within the speculative grain range. So the natural holders of triple Cs are more risk oriented investors and that would even include some funds that specialize in distressed debt. Now some of these triple C holders are bond mutual funds and they're in competition with other bond mutual funds and for many The investors, the competition simply as well, who's got the highest yield, they're not necessarily sophisticated enough to say, well, what kind of risk are they taking to achieve that? And of course, the fund manager will say, oh, well, we have really smart analysts. So they find these companies that are underrated. So it's not like we're taking a lot of risk, we're getting really good deals. So when the market sells off, in the nature of mutual funds, you have a lot of investors who are renting that investment rather than buying it. And of course, they have the ability to redeem that same day. Very rarely we see mutual funds put gates on limiting the ability to exit because that hurts them competitively down the road. So the funds that do have sell-offs because their values have fallen, their net asset values have declined. Suddenly, they have run-offs, they have to liquidate bonds to meet redemptions. And that creates very heavy selling pressure in issues that don't have deep markets or good liquidity to begin with. So you can see some real gapping in the prices on those triple-sea securities. I think you also back out the default rate market is pricing and then combined with the Moody's forecast, ideas there that distressed is attractive when the market forecast is a percentage point higher than what Moody's is forecasting. Where's that reading today? Well, currently, Moody's is forecasting 3.1% default rate and that's on US speculative grade bonds over the next 12 months. I use a methodology that's different from what you see elsewhere because I've shown that looking at the spread versus treasuries to get at the expected default rate is flawed in several respects. But the methodology I use shows that the implied forecast of the market is for just a 1.8% default rate, so more than a percentage point below where Moody's is forecasting it. So the distressed market as a whole is not especially attractive right now. But I would hasten to say that within the distressed market, there are always a few individual situations that offer very good risk reward trade-offs. If you think about an individual, a trepacy credit rather than the index, it's a spread the right measure to measure that or how do you think about it? At a minimum, I'd say you would want to consider some other metrics along with the spread. For example, what dollar price is the bond trading at relative to its expected recovery in the event of default and what is the bond's current yield that is the coupon rate divided by the dollar price? So that's important because in the worst case scenario of a default, you'll earn back more of your investment prior to the default, the higher the ratio is. In extreme cases, some of the distressed investors will reach a point based on the dollar price in the current yield where I'll say, I'm indifferent to whether the company defaults are not because I'll earn such a high current yield that I'll be in good shape even if a year or two down the road, the company defaults, I'll recover a portion of my investment and in addition, I've made so much in current yield that I'll have had a very attractive outcome. So I think the bottom line is I agree with you that the spread tells only part of the story about a lower rated bonds value, but I don't think there's a single measure that replaces the spread and tells you everything you need to know. Alongside the index, you also run a screen that picks out severely undervalued issues. I think the record is that 85% to 90% of them be the index over the following 12 months. How does this screen exactly work? Well, the screen is based solely on data from the company's financial statements. Now, I, you know, certainly not someone that takes everything in financial statements at face value, I have actually a book called Financial Statement Analysis of Practitioners Guide. Now in its fifth edition, that specifically points out to the trickery that's used by companies in reporting their finances. But nonetheless, just using that financial statement data that tells us what sort of spread that the bond ought to have, if not for unusual factors, such as irregularities and supply and demand, or perhaps the lingering effect of a bad quarter or a while back. And we put together a score based on the financial data. And I should mention that the bond could make the list whether it's a high end or a low end credit, the qualification is simply that the actual bond spread is out of line with what the model predicts. What is on the list right now? Could you walk us through some of the most undervalued names? Yes. Let me list five of those that are near the top of the list in terms of the degree of undervaluation, first would be pay safe finance, which is a 14% bond due in 2029. Then there's FMC 5.65% due in 2033, icon enterprises 4 and 3/8% due in 2029, cogent communications, 6.5% due in 2002, and Owens Brockway 7.25% due in 2031. Interesting. It's the coincidence by those coming up is that due to industry or what are the privacy there? No, you know, there are 133 bonds that we classify as significantly undervalued versus about 1,800 in the index as a whole. And they are spread across a variety of industries, the most heavily represented industry currently as financial services, so that would account for that or pay safe finance would be in that group. And after that come media and healthcare, but it really is a very company specific situation. The cheap bonds run the gamut from double B plus all the way to triple C minus. So I think it's an interesting aspect of the market that the bonds really do perform while there are some group of facts, they're very company specific, and that's why I find that managers in the high-yield space really say that they take into account some of these bottom or top-down factors, but they really emphasize the bottom-up analysis with analysts who are specialized by industry and really know those businesses very well. And you think that makes sense, the bottom-up approach, do you think more the top-down approach makes sense or is it a combination? Well, I think that some managers do underestimate the impact of the top-down factors because they're used to looking at companies, typically portfolio managers themselves work their way up from being industry specialized credit analysts, and they take great pride understandably in that in being able to say, okay, this company is not going to do better or worse simply because that industry grows into favor or out of favor, and there's a lot of truth to that. But I think it's undeniably when you look at the data, there's no question that even a a good credit in a bad industry. We'll feel the effect of the market losing interest in that industry or suddenly thinking that it's turning around and we'll look at the best in the worst companies within that industry to find where they can get the most mileage out of that change. That's true. What are the key drivers usually revealing this undervaluation? Well, if you're drawing it now at the sector level or at the individual credit level. At the individual level, so I mean, is it, I don't know, is it, for example, assets? I heard that's, for example, a very widely used indicator for quantitative. Yeah. Well, I have to say that our, the details of this model are not disclosed. Everything else that I do on 100% transparent and people can recreate the models themselves and satisfy themselves that they're valid. This is kind of a special case because there is a proprietary value in this model. So we've had a company that does or narrowly their focus is on validating performance records of managers. But we had them take a look at our results to a test to that fact that the performance had been, as you stated earlier, 85 to 93%. With the exception of periods where the high-owned market and financial markets in general are doing so terribly that nothing works. But under any other normal circumstances, you have a very high success ratio. I'd say that the factors that managers who are looking at that on a hands-on basis, company by company, not doing it on any kind of a formula basis. But looking at various factors, they'll look at, I think the free cash flow, there I run into annals and say that's the only important thing in the whole picture. The company has good free cash flow, everything else falls by the wayside. But traditionally, ratios of debt to cash flow, people would sometimes use EBITDA as their measure, not a perfect measure of cash flow, but they'll look at that. And then cash flow rather than earnings coverage of interest would be other measures that people would put a lot of emphasis on. In the 10 to 15% which do not work, what is usually, what usually went wrong? Well, let me say about that. By definition, at any period, the half of the companies in the index will underperform the median of the index. And it's not to say that anything went wrong at those companies is just that there's only space for 50% in the top half and some are going to have been the bottom half. So for the 10 or 15% of cheap bonds that didn't get back to their fair of values and outperform the index, it's not clear that in every case something went wrong, it may have been that whatever was holding them back causing to be wider than their fair of value spreads remain the case. The market didn't change its mind over that period and it wound up not outperforming the market for that reason. It could have changed the month after that or six months after that. And yes, some of the bonds that I'll underperform the index did have a setback of some kind that could have been for reasons that couldn't possibly have been foreseen. The company could have lost a major customer. It could have had an accident at a plant company could have encountered new competition that hurt their profit margins. 10 or 15 years ago the leveraged finance market was largely a hired market today. It splits between high yield leverage loans and private credit and private credit has taken most of its growth. What has that done to the market you model? Well, the market has not grown in terms of amount of standing over the last five years. By contrast, the total amount of standing grew at about a 5% compound annual rate from 2011 to 2021. If that growth had continued at the same rate, the market would now be a half a trillion dollars larger than it is today, which would make it larger by about one third than it currently is. So, would you say that public credit spreads still represent the asset class when a lot of let's say the riskier borrowers have migrated towards private credit? Well, it's important to point out that an asset class is different from a universe of issuers. The high yield spread represents the risk specifically in the public high yield bond market. Now, some of the companies in that market also borrow in the private credit market or in the syndicated bank loan market. There's quite a bit of overlap between the two and the high yield bond issuers have not certainly in every case abandoned high yield bonds and said we're going to rely exclusively on private credit. And some of those high yield bond companies also finance in the common stock market or the preferred stock market. Each of those markets has measures of its particular risk and those measures make them separate from the spread on high yield bonds because they represent other asset classes. So, I think the analysis we do on public high yield bonds is still valid. It's just that some of the capital they raise is now being done elsewhere and that's perfectly fine. Those markets have their functions to serve. And if the private credit market gets through the next recession and I think it will be necessary for private credit market to make some changes after that event in the way their contracts are written. But if they do that and survive and remain an important part of the market they'll serve a very useful function just as leverage loans and high yield bonds do in their own ways. Absolutely, they diversify funding sources. In the high yield market we do see new kinds of boroughs arriving, especially a high related bonds are about now 4% of the index and could get to 7 to 10%. And Paramount Skydance is also as we speak entering the index as well. How do you think about that migration and new issues a new completely set of issues is entering the market? Well, the AI issuers clearly have a very large appetite for that. The data center is in particular very expensive and that makes it possible that the new supply from that AI sector could eventually strain the high yield markets capacity to absorb it at least in the short run. So that will not change the fundamentals for the rest of the high yield issues. So we might see an extended period of the high yield universe trading at a discount to its fair value because the supply demand factors have been very unusual for some period of time. As we come towards the end of the interview, how do you separate a safer index from a more expensive one? Because I think that's the question we are trying to answer throughout the whole interview. Well, there's only one high yield universe, but at any given time there are some bonds that are more attractively priced than others. It really comes down to the risk of the market, the universe itself. which is, as I mentioned earlier, a lot different from it was a decade ago, or certainly 30 years ago, but it's not going to change a lot from one year to the next. But over that, a 12-month period, the financial conditions, the outlook for the economy can change very significantly. So, the safer market is one where the spread is compensating you adequately as in other parts of the financial markets, the bottom line really is risk versus reward, a more expensive market is one where the risk is there. It may be, especially high, may be especially low at a particularly point, but if the market is not rewarding you appropriately for that risk, that is an expensive market and one where you're very vulnerable to the market very suddenly finding the right level to price that risk at. What are the indicators that favor a higher allocation into high yield? Well, I don't get involved in economic forecasting, but as a general statement, you're likely to increase your high old allocation from here. If you think that GDP and corporate earnings will be even better in 2027, then the market currently believes. Now, as I mentioned earlier, energy is the largest component of the high- old index. So, if you think oil prices are going higher from here, that could be because you see the war in Iran worsening rather than coming to a resolution. Soon, there will be another factor in favor of a larger high- old allocation, but I would put out the caveat in that case that you think other companies will be able to pass along their higher energy costs to their customers. Marty, that was super interesting, the whole interview, where can people find you and understand more of the work you're doing? Well, you can reach me on LinkedIn. Also, I'm on Bloomberg, you can find me there. I would caution that if you have high- old bonds for sale, save your time, because I don't manage a high- old bond portfolio, our money management business is involved in a variety of income investments, and we primarily use ETFs for some of those including high- old bonds. But, you know, absolutely happy to hear from people if they have some thoughts, questions about what I do. Marty, thank you very much for coming in the show. If you have enjoyed this one on high- old spreads and the market in general, please follow and subscribe for ever you get your podcasts and see you next time.