A not so new trend has been forming in the last several months, and it suggests that credit markets may be loosening up for the riskiest borrowers.
Back in May, Beazer Homes USA issued non-investment grade (junk) debt to the tune of $300 million. What was notable about this particular issuance is that it was done in the midst of the Greek debt crisis, and included fewer covenant restrictions than similar financings by the Company during the height of the real estate bubble. Subsequently, a number of US corporations have issued large amounts of non-investment grade notes that are eerily similar to the "covenant-lite" loans that were so roundly criticized during 2008 and 2009.
What is driving this trend? Covenant Review and Moody's have both cited a recent decline in default rates of junk yield bonds, a flood of cash coming to junk bond mutual funds, and a relative dearth of new issuance. A classic case of demand exceeding supply.
In the equity market, the same trend occurred in the Russell 3000® Index. Those companies with higher betas (riskier) dramatically outperformed their low beta counterparts by a margin of nearly 400 basis points in the third quarter of 2010. The same was true for those companies in the Russell 2000® Value Index. Investors are searching for excess returns and are willing to assume more risk to find it. We think that this trend is likely to persist in this period of slower economic growth.
Slower economic growth and limited capital investment tend to go hand in hand. While the academic debate centers on which of the two causes the other, the simple fact is that both of them together cause capital to sit idle. As the idle capital sits, credit investors begin to hunt for yield and become less restrictive in their standards. Combine that with pent up cash on corporate balance sheets, and piled up in buyout funds, and we end up with the perfect combination to begin a wave of equity consolidation – a buyout wave. So far this year, through the middle of October, LBO volume is at $60 billion, nearly 3x the total volume of 2009.
Pacific Ridge Capital Partners
About Pacific Ridge Capital Partners
Pacific Ridge Capital Partners is an employee-owned firm. We generate our own investment ideas using fundamental analysis and bottom-up stock picking. The investment team applies a consistent, patient and disciplined process that results in low turnover and stability. Our proven philosophy has performed well over many investment cycles and it is the consistent application of this strategy that makes Pacific Ridge unique.
The principals of Pacific Ridge Capital Partners are invested along with our clients in each of our strategies.
PRCP Small Cap Value – Our Small Cap Value strategy generally purchases stocks in the bottom three-quarters of the Russell 2000® Index. This smaller capitalization segment has a large number of underfollowed companies, providing us the greatest opportunity to exploit market inefficiencies. The typical range of holdings is between 100 and 150.
PRCP Micro Cap Value – Our Micro Cap Value strategy generally purchases stocks in the Russell Microcap® Index. This segment is widely underfollowed, providing us the greatest opportunity to exploit market inefficiencies. The typical range of holdings is between 50 and 80.
We believe these market cap segments offer great potential returns and additional diversification for our clients. For further information about Pacific Ridge Capital Partners and our investment strat- egies, we invite you to contact Tammy Wood via email at Tammy.Wood@PacificRidgeCapital.com or by phone at (503) 878-8502.
Pacific Ridge Capital Partners, LLC (“Pacific Ridge”, “PRCP”, or “the Firm”) is an employee-owned investment advisor registered with the Securities and Exchange Commission under the Investment Advisor Act of 1940. The Firm was established in June 2010, and has one office located in Lake Oswego, Oregon. Pacific Ridge claims compliance with the Global Investment Performance Standards (GIPS®).
Sources: Pacific Ridge; FactSet Research Systems (“FactSet”); and Russell Investment Group (“Russell”) who is the source and owner of the Russell Index data.
The current annual investment advisory fees for the portfolios managed in the Firm’s Small and Micro Cap Value strategies are 1.00% and 1.50% of assets, respectively. Returns for the composites are presented gross and net of management fees and other expenses and includes realized and unrealized gains and losses, cash and cash equivalents and related interest income, and accrued based dividends. The Firm calculates time weighted rates of return by geometrically linking portfolio simple rates of return at least monthly, with adjustments made for significant external cash flows. The composite returns are calculated by asset weighting the individual portfolio returns using beginning of the period values. All returns are calculated after the deduction of the actual trading expenses incurred during the period.
The information provided should not be considered a recommendation to purchase or sell any particular security. There is no assurance that any securities discussed herein will remain in our strategy at the time you receive this report or that securities sold have not been repurchased. It should not be assumed that any of the holdings discussed herein were or will be profitable or that the investment recommendations or decisions we make in the future will be profitable or will equal the investment performance of the securities discussed herein. Past performance is no guarantee of future results.
Although the statements of fact and data in this report have been obtained from, and are based upon, sources that the Firm believes to be reliable, we do not guarantee their accuracy, and any such information may be incomplete or condensed. All opinions included in this report constitute the Firm’s judgment as of the date of this report and are subject to change without notice. This report is for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security.
The Russell 2000® Value Index measures the performance of the Russell 2000 companies with lower price-to-book ratios and lower forecasted growth values. For comparison purposes, the index is fully invested, which includes the reinvestment of income. The return for the index does not include any transaction costs, management fees or other costs.
The Russell Microcap® Value Index measures the performance of the microcap segment of the U.S. equity market. For comparison purposes, the index is fully invested, which includes the reinvestment of income. The return for the index does not include any transaction costs, management fees or other costs.
Returns and asset values are stated in US dollars.