A Year in Review – Looking back at 2018
What a great year 2018 was for Ballast. We completed our second year of operations, with goals of providing clients with security, stability, and innovative investment strategies. The year brought many unanticipated events – some investable, others not – and we tried to comment in our newsletter and blog on ones 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, is typically 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 Ballast clients’ portfolios during 2018: Dollar General, Priceline, and Time Warner. 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:
Bayer – The German group operates in pharmaceutical, consumer health, and crop science industries. In order to complete its acquisition of US-based Monsanto, which would increase the size of its crop science division, Bayer was issuing $25bn of debt. This was a large overhang to the credit – in terms of size for the market to digest – and the increased leveraged caused the credit ratings to slip from single-A to triple-B. While it is still investment grade, it is lower quality and yield commensurate. The market anticipated this in the months leading up to the debt issuance, and Bayer credit spreads widened 50bps. We assessed the two companies and felt the extra spread was more than commensurate for the combined company’s ability to deleverage over the next couple of years.
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. Another example of an ABS investment includes agency residential mortgage-backed securities (RMBS).
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 and credit characteristics for buyers. Ballast acquires the short-term (“front-end sequential”) to acquire decent yield without much principal or credit risk.
Non-core Investment Strategy
For many clients, especially in the current market, core investments do not provide enough returns alone. Ballast adds incremental yield to client portfolios by investing in non-core opportunities. These include credits of high (and low) quality and 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 2018:
General Electric – The former industrial titan has become a hollowed version of its earlier might. The year 2018 brought several major capital charges: 1) in a life insurance unit and 2) in a major acquisition from three years prior, where carrying value was no longer supported by earnings expectations. GE’s balance sheet is highly leveraged and now has less reported assets (following the charges to support the leverage). GE’s CEO at the beginning of 2018 was no longer the CEO by the end of the year. Both the stock and bonds performed poorly during 2018. We saw opportunity arise during a major credit market selloff to leg-in on the credit at opportunistic price (for what remains, for now, as an investment grade credit with, in our opinion, enough asset coverage and runway to right-size the balance sheet).
Third Point Reinsurance – Here is a little-known reinsurance company with an investment grade balance sheet and public debt yielding substantially more than similarly rated peers. Because the amount of debt outstanding is small (not index eligible), it is difficult to source after initial issuance. Ballast has relationships with the brokers that could source the bonds, and after much effort, we were able to add Third Point to many client accounts.
Seaspan Corp – Seaspan is a little-known global freighter ship owner under the influence of two billionaires. While its industry has fallen on hard times, Ballast is interested in Seaspan since several key elements are aligned to create an attractive investment opportunity. Given the asset intensiveness of owning and leasing ships (and despite being unrated), Seaspan has publicly traded senior debt outstanding. These notes command a hefty yield. The parties of interest at Seaspan are Prem Watsa (often considered the Warren Buffett of Canada) and David Sokol (a former top lieutenant of Berkshire Hathaway). The two men have joined forces with Seaspan to consolidate its industry. Prem Watsa, through his insurance company (much like Buffett and Berkshire Hathaway), has committed $1 billion in equity capital to Seaspan to make acquisitions and shore up its balance sheet. After considering the pedigree and track record of the key people involved, the size of fresh equity capital infusion, the management objective to achieve investment grade ratings, and the various nuances to the bonds that keep other investors away (and, therefore, yield up) – Ballast saw attractive opportunity to add yield to clients’ 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 the year. Although we have not acted on them, we continue to monitor each.
Major wildfires in California for the second year in a row caused substantial damage to surrounding communities. According to California law, the electric power utilities may be held liable for damages if their equipment is at fault. Several of the wildfires appear to have been caused by electrical equipment. This has resulted in substantial capital erosion of the major utilities operating within the state. Bankruptcy is a possibility for at least one of the utilities, and stock and bond prices have gyrated during the second half of the year. We think the situation will provide an attractive investment opportunity, but we have yet to find good entry.
Another area of interest for us was the property/casualty insurance and reinsurance industry. The year 2017 brought significant economic loss due to natural disasters in North America, and 2018 brought more losses, albeit much reduced from the year prior. With each years’ economic losses came significant insurance losses. Although stock prices of many insurance companies suffered meaningful decline due to capital erosion in 2017, we found limited opportunity to invest, so we did not. During 2018, these stock prices went sideways so we, again, did not find any places to invest. No good opportunities appeared in the credit of the insurers either. If industry losses are elevated again in 2019, good opportunity may arise, but we expect the status quo of a generally soft insurance market in the absence of additional insured losses.
Another area of interest was offshore drill rig companies. Some of the biggest names in the industry include Diamond Offshore, Transocean, and Ensco. The industry has suffered as oil price declines of 2015/2016 led to drill fleets being underutilized. As an asset intensive industry, leverage use was (and is) high. As the oil market downturn took hold, the offshore drillers fell to financial distress and were forced to deleverage. After a couple of years of some oil price recovery and deleveraging & refinancing, we think at least some of the industry has de-risked enough for our interest. The oil prices that declined during the fourth quarter have brought this opportunity back to center.
The new year always brings with it more challenges and opportunities. This new year brings global central bank balance sheet reductions, rising short-term interest rates, elevated equity market prices, and plenty of unknowns. With more insight into what Ballast did during 2018, 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 2019. Click here to see our goals.