PIA High-Yield Investor Scores by Avoiding Shaky Sectors

(Editor's note: TheStreet today named 82 mutual funds and exchange traded funds, or ETFs, winners and runners-up in its second annual awards ceremony. A list of the funds and related articles can be found on the awards page.)

NEW YORK (TheStreet) -- During the volatile trading of last summer, many investors sought safety in Treasuries and dumped high-yield bonds, which are rated below-investment grade.

Bonds of financial companies suffered particularly big losses as investors worried that the euro crisis could lead to bank defaults. But throughout the hard times, PIA High Yield (PHYSX) managed to limit losses, steering away from financials and other shaky sectors.

Thanks to such on-target moves, the high-yield fund returned 4.5% in 2011, compared to a return of 2.8% for its average peer, according to Morningstar. Besides delivering strong returns, the fund also achieved tame risk scores. That showing enabled PIA to win TheStreet's Best Funds 2012 award in the corporate high-yield bond category. The runner-up is CNI Charter High-Yield Bond (CHBAX).

James Lisko

To find promising bonds, the PIA portfolio managers start by evaluating industry categories, looking for the sectors that have reliable cash flow and the ability to survive recessions. The fund overweights promising sectors and has little or no exposure to shakier areas.

Last year, PIA had only 1% of assets in financials, while the Barclays Capital High Yield index held 11% in the industry. The shift away from financials proved well-timed. During the third-quarter turbulence, PIA declined only 4.1%, outpacing its average competitor by 2 percentage points.

Another successful strategy was to underweight communications bonds, since the portfolio managers worried that the landline business would continue stagnating. The fund had only 4% in the sector, compared to 15% for the benchmark.

The portfolio managers -- James Lisko, Robert Sydow, Timothy Tarpening and Kevin Buckle -- overweighted industrial issues, a move that produced nice gains. The fund had 25% of assets in the sector, compared to 8% for the benchmark. Buckle says he favors industrial bonds because many issuers have cut costs in recent years. That is enabling the businesses to report higher margins as sales recover. "The operating structures of these firms have gotten better, and they are more able to withstand recessions," says Buckle.

While most competitors focus on larger issues, PIA emphasizes bonds from small companies. The aim is to find bonds that are not well-followed and may be mispriced. The small bonds tend to be rated B or lower. Many competitors emphasize issues that are rated BB.

PIA's focus on B-rated bonds was a handicap during much of last year. As investors favored high-quality issues, BB-rate bonds on average outdid B issues. But PIA managed to shine because many of its holdings proved to be undervalued, and the bonds performed better than the market had anticipated.

Strong-performing issues include bonds from United Rentals (URI), which rents backhoes and forklifts to businesses. Another favorite issuer is Rent-A-Center (RCII), which leases appliances and furniture to consumers. Buckle says that in recent months rental prices have been reviving as the economy improves.

PIA reduces its risk levels when markets appear shakier. Worried about market uncertainties last year, the fund began buying bonds with shorter maturities, which are less volatile than long bonds. The average maturity of the portfolio was 5.7 years, compared to 6.7 years for the average competitor. The short bonds proved to be relatively resilient during the summer downturns.

Besides buying shorter bonds, the fund also sought to reduce risk by favoring senior secured bonds. In the event of default, investors in these bonds would be paid before unsecured creditors. The move proved on target, because senior bonds performed better during market turbulence.

Buckle argues that the outlook for high-yield bonds remains solid. The bonds yield 7%, a tempting payout at a time when 10-year Treasuries yield 2.0%. The default rate remains below 1%. He says the default rate should remain modest. "If the economy can grow at a rate of at least 1.5%, then we should not see a big increase in defaults," he says.

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1. To be eligible for consideration, an open-end mutual fund needed at least a three-year history on Dec. 31, 2011, and still be accepting new assets from retail investors; for exchange traded funds, a one-year history.

2. Half of the rating is based on performance metrics, including total return minus expenses, with a weighting to give long-term performance greater emphasis.

3. The other half of the rating is based upon risk metrics, including standard deviation, size of trough-to-peak (drawdown factor), semi-standard deviation and beta. The lower the risk, the better.

4. Top and runner-up funds and ETFs were selected in a variety of categories (funds and ETF were placed in categories via Lipper data).

Stan Luxenberg is a freelance writer specializing in mutual funds and investing. He was executive editor of Individual Investor magazine.