What a year 2020 was! Ballast completed our fourth year of operation, with goals of providing clients with security, stability, and innovative investment strategies. The year took everyone on a wild ride – we found some of it to be investable – and we tried to comment in our newsletter and blog on things we found more noteworthy. As the year closes, we wanted to take the opportunity to reflect more wholly on what we did during the year.
Core Investment Strategy
Among other client constraints, return requirement remains top-of-mind as we build and maintain investment portfolios. The bedrock with which Ballast portfolios are built upon is core, yielding investments. The average investor requires a well-diversified portfolio, and so, investment positions within are numerous. These core holdings provide relatively low-risk return and cash flow for clients in fulfilling their investment objectives.
Credit – Credit provides the bulk of the yield allocation for achieving desired cash flow and return within an investment portfolio. The risk premium, or credit spread, may be higher than comparable maturity securities due to risk considerations like collateral, degree of leverage, management, credit ratings, et cetera. Nevertheless, with a little bit of analysis and monitoring, there are high-quality credits worthy of investment. Here we list some examples of core yielding bonds put into many Ballast clients’ portfolios during 2020: FedEx, Molson Coors, Ralph Lauren, and Ross Stores. Our clients may recognize these as high-quality, household names. Other high-quality names enter the portfolio through one-off market events to contribute incremental yield within what Ballast views as core:
Mylan Laboratories –Mylan (now Viatris, as you will read shortly) is a name less familiar to people. Mylan is a global pharmaceutical that focuses on generic drugs, though its best-known product is a non-generic product called EpiPen. As health care costs rise and receive due attention, Ballast believes generic drugs will remain of strategic importance. Already one of the largest generic pharmaceutical companies in the world, Mylan just got bigger by combining with Pfizer’s established pharmaceutical division called Upjohn, which was spun-out of Pfizer into a new company for the purpose of merging with Mylan. The combined group has been renamed Viatris. During the turmoil earlier this year we had the opportunity to buy Mylan bonds at a level we thought was attractive for a company with constructive prospects and especially considering it was set to merge with Upjohn. We viewed this latter point as credit positive and expected credit rating to migrate higher over the near-term (S&P Ratings has since moved their credit rating outlook to positive). In short, our expectations were that the bonds provided good value as stand-alone (as Mylan) and better value as combined (as Viatris). We feel good about this position.
RMBS – Residential mortgage-backed securities (RMBS) come in agency (guaranteed) or non-agency (non-guaranteed). The latter is underwritten by Ballast on various factors including loan pool credit score, diversification, structural support, and LTV. RMBS is not a large component of most accounts and our clients are more likely to see agency RMBS.
ABS – Asset-Backed Securities provide yield with substantial risk protection through strong collateral or structure. United Airlines and American Airlines are examples of investments many Ballast clients would recognize. The bonds are highly rated and secured with the airlines’ aircraft. With the substantial pullback in air travel during 2020 we have given extra scrutiny to our aircraft-backed bonds, monitoring the aircraft collateral and their flight activity. While the airline industry is not yet free and clear, after reviewing underlying aircraft activity we remain confident our bonds have appropriate support.
CMBS – Commercial Mortgage-Backed Securities are used by Ballast to generate incremental yield for short-term, or cash-like, allocations within client accounts. CMBS are pools of loans backed by properties such as Office, Multi-family, Retail and Industrial properties. These securities are structured to provide short-term or long-term cash flow, as well as credit characteristics for buyers. Ballast acquires the short-term (“front-end sequential”) to acquire attractive yield without much principal or credit risk. This last point is critical when considering the year 2020 and the impact of retail and office space. As relates to short-term investing we are highlighting, we intentionally invest in the senior piece (“top of the stack”) where there is sufficient support to protect principal against severe loss scenarios.
Non-core Investment Strategy
For many clients, especially in the current market, core investments do not provide enough yield alone. Ballast adds incremental yield to client portfolios by investing in non-core opportunities. These include credits of high (and some low) quality, as well as strategies of high yield and total return. What is common of these non-core opportunities is that they require Ballast’s vigilance, patience, and analysis. Here we list some examples of investments made during 2020:
Continental Resources (CLR) – a shale oil and gas exploration and production company. Despite what the pandemic did to the energy sector, we believe the company’s short-term outlook is good, supported by modest cash flows and backstopped by a large credit facility. As one of the stronger (thinking in terms of size and credit rating) in the shale exploration and production sector the company also stands to benefit from consolidation, opportunistic acquisitions of distressed assets, and tailwind of any recovery in oil prices. We found an opportunity during the market turmoil to add Continental to many accounts.
EQT Midstream (EQM) – a midstream pipeline natural gas pipeline in the northeastern US that is sponsored by EQT, one of the largest shale natural gas exploration and production companies in the US. Though natural gas prices have been under immense pressure from the competition in hydraulic fracturing, EQT remains among the stronger in the sector and the natural gas market, like its shale oil counterpart, is set to rationalize given the level of distress experienced throughout the energy industry during 2020. Natural gas is a primary and growing power generation input and is also a growing export in the form of liquid natural gas (LNG). A combination of factors – above and other – combined with an attractive opportunity gave us confidence to add EQM to many accounts.
National General Holdings Corp (NGHC) – a mid-sized insurance company in the property and casualty market. The company has been moderately successful as characterized by growing, stable, and profitable insurance underwriting. This gives the investment a solid base. AllState, a well-known and high-quality insurance company, agreed to acquire NGHC during 2020. While the common stock and bonds of NGHC responded to the news as you would expect, we found an attractive opportunity to add NGHC preferred stock to many accounts.
Warrior Met Coal (HCC) – a metallurgical coal company based in the US. HCC has mining assets primarily in Mississippi. In 2015, with interest in distressed investing opportunities of the energy and mining industries, we followed the bankruptcy of Walter Energy, a metallurgical coking coal miner that failed spectacularly during the broad global economic pullback. During that cycle, savvy distressed debt investors recovered credit losses by taking over Walter’s core mining assets in Alabama. Those assets became HCC. Warrior Met management, with bankruptcy burned into their recent memory, is running the company conservatively with a large liquidity position. The company’s bonds have first lien on the mines, which we view as high quality and validated by the recoveries of the distressed investors just a few years ago. Further, we view the mines as strategic to the US considering global political economy turmoil. More trade wars would further underscore the value of the US-based mines. Although we did not find opportunity with Walter in 2015 the prior experience benefited us in 2020. We found an attractive opportunity to add HCC to many accounts.
Each day, investing is busy and brings a new rock to turn over. With all the things Ballast examines and thinks about during the year, it is difficult to note them all, but there were a couple of areas we found interest in during 2020. Although we have not acted on them, we continue to monitor each.
The energy sector has suffered greatly due to a confluence of factors – capital flowing into the sector allowed shale operators to bring new supply on at levels that were probably not healthy for long-term economic health of the sector; the pandemic took demand offline at a particularly vulnerable time; and public interest in electrification of vehicle fleets have driven energy prices lower and have turned investor expectations sour. We hold another view – that the sector is facing capital rationing, which brings with it greater discipline, or supply constraint; that we will emerge from this pandemic with rejuvenated “energy” to go about and live, thereby increasing demand; and that vehicle electrification may be the future but we believe the adoption timeline is exaggerated. Thus, we look to the energy sector with great interest in the new year.
Another area of interest but with less of a formed view is real estate. Several sector have fallen into distress. As an investment group emphasizing basis, market dislocations such as happened in 2020 provide attractive opportunities. Two noteworthy sectors of real estate are office and hospitality. Both have use in the unknown future, they just face a great deal of uncertainty. Therefore managing basis – or entry price – is critical but second to analyzing and knowing what it is you are buying. We continue to evaluate opportunities here.
The new year always brings more challenges and opportunities. This new year brings continued coronavirus spread and economic closures. It continues as two economies – those that survive and thrive partial shutdowns and those that do not. With capital market valuations at high levels despite what could clearly be economic sinkholes investors may need to tread carefully. With more insight into what Ballast did during 2020, clients can expect the same commitment in the year ahead. We look forward to navigating the challenges and providing our clients with security, stability, and innovative investment strategies in 2021.
A complete list of all recommendations will be provided if requested for the preceding period of not less than one year. It should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities in this list.