As specialist high yield manager DDJ Capital Management marks its 25th anniversary, we look at the investment process developed by its co-founder.
This past March, DDJ Capital Management, a boutique asset management firm based in Massachusetts, marked its 25th anniversary.
Since its inception in 1996, DDJ has consistently applied the investment process originally developed by its co-founder, president and CIO, David J. Breazzano. Such process is predicated on exhaustive fundamental and legal analysis with an emphasis on exploiting the inefficiencies within the high yield and bank loan credit market.
“I am so proud of what we have been able to build at DDJ over the past 25 years,” said Breazzano.
Mr Breazzano has more than 40 years of experience in high yield, distressed, and special situations investing. Prior to forming DDJ, he was a portfolio manager of Fidelity’s Capital & Income Fund, which was one of the largest high yield funds in existence at that time. Prior to joining Fidelity, Mr Breazzano was a vice president and portfolio manager at T. Rowe Price Associates, and an analyst at First Investors.
During the last two-and-a-half decades, DDJ has garnered the attention of a diverse institutional client base located across North America and Europe. As of March 31, 2021, DDJ oversees more than $8 billion in capital, with approximately 35% of the firm’s assets managed on behalf of clients domiciled in Europe.
A differentiated approach to high yield
Since the firm was founded, its sole focus has remained investing in the high yield market. The DDJ U.S. opportunistic high yield strategy, incepted in 1997, employs DDJ’s time-tested research process that the firm believes is differentiated from those employed by its peers.
As Breazzano noted, “Our approach is to determine the value of the business, then look at the business’s capital structure to identify where the best opportunities are within that capital structure, whether bond or loan, which we believe gives us a more attuned focus on downside protection.”
Over its history, DDJ has found that the lower-rated segments of the high yield market offer the most fertile ground for uncovering such opportunities. Therefore, portfolios pursuing the DDJ U.S. opportunistic high yield strategy tend to be tilted to credits rated B and below.
DDJ believes that the CCC-rated segment is often overlooked, or even more often, disparaged. However, for those willing to spend the necessary time and effort required to uncover value in this area of the market, attractive absolute and relative return opportunities are available.
DDJ constructs reasonably concentrated portfolios comprising debt instruments of valuable businesses that DDJ believes are able to meet their financial obligations. At its core, the research process was designed by Mr Breazzano to identify mispriced risk, thereby enabling portfolios to earn a higher yield premium relative to the broader high yield market without otherwise incurring incremental credit risk. That higher yield premium can also provide investors that have a need to meet certain obligations with a useful source of regular income in the form of higher coupon payments relative again to the broader high yield market.
The firm’s capabilities lead to new opportunities
As one might expect, the appetite for CCC-rated debt is very client specific, as are allowances for investments in bank loans. However, over the years, DDJ has remained flexible when employing its brand of bottom-up fundamental research and portfolio construction to successfully achieve its clients’ long-term investment objectives.
For example, in pursuing DDJ’s upper-tier U.S. high yield strategy, which was incepted in 2012, DDJ applies the same research and portfolio construction techniques to the higher-rated segments of the high yield market in order to achieve the objectives established by certain clients.
As Breazzano remarked on the strategy’s beginnings, “An existing Dutch client that pursued DDJ’s U.S. opportunistic high yield strategy needed to reduce its CCC-rated debt and bank loan exposure, but they valued our process and asked if we could apply it to the higher-rated, more liquid segments of the high yield bond market.”
He added: “We were happy to do so, and maintain an excellent relationship with this client, which has helped us build a strong track record in that space.”
DDJ’s ability to customise the solutions required by its clients, prospective clients and consultants has led to a diverse set of leveraged loan strategies as well as a more diverse client base for the firm. DDJ’s distinctive approach is also often used to complement an institutional investor’s existing high yield allocation, especially where a more benchmark-oriented approach is already employed.
New opportunities in integrating Environmental, Social and Governance (“ESG”) factors.
Since 2014, DDJ has worked to enhance and formalise its internal ESG capabilities. This process has included steps such as becoming a UNPRI signatory in 2016 and developing a formal Responsible Investment Policy, as well as formal ESG training for all research staff.
As a credit-oriented investment manager, limiting an investment’s downside is a fundamental principle of DDJ’s investment philosophy. Along these same lines, DDJ believes that unmitigated ESG risks can increase the financial downside of an investment.
Accordingly, DDJ believes that including these factors in its bottom-up fundamental credit analysis better enables its investment team to identify certain risks that may adversely affect an issuer’s creditworthiness. In addition, DDJ also seeks to identify issuers that exhibit positive ESG factors or improving ESG trends that DDJ believes have not been identified by the broader market.
Importantly, ESG integration is not just part of evaluating new investment opportunities. Rather, DDJ believes that the continuous monitoring of existing positions is the best way to track existing ESG factors as well as to identify new ones before they materialise.
DDJ believes that its efforts to integrate ESG into its investment process can be best thought of as a journey. Over time, the firm has made incremental enhancements in this area, often working closely with clients to help achieve their goals. In recent years, these developments have included signing on as a public supporter of the Task Force on Climate-related Financial Disclosures (“TCFD”) as well as launching simulated high yield ESG portfolios and producing robust reporting around such. However, its journey is not yet complete.
The firm believes that its research and portfolio construction methodology is well suited for ESG integration and accordingly the process of more formally assessing ESG factors in its investment process has been smooth.
Ultimately, DDJ recognises that its clients have selected the firm to manage their assets primarily to maximise total return while minimising risk, in each case in accordance with the desired investment strategy and any customised individual guidelines.
Nonetheless, Breazzano acknowledges that “[i]n pursuing this objective, DDJ believes that it has a responsibility to take into account non-financial factors when allocating client assets to various investment opportunities”.
Although the markets for high yield bonds and bank loans have changed considerably over the last quarter-century, DDJ’s bottom-up, fundamentally driven and long-term investment approach remains intact and as capable as ever in identifying mispriced investment opportunities.
“Over the last 25 years, it has been both a pleasure and a privilege partnering with clients, consultants and colleagues to build and expand our business,” says Breazzano. He adds: “Offering a truly differentiated approach to the high yield market is a legacy that all of us at DDJ are proud of.”
David J Breazzano, the co-founder, president and CIO of DDJ Capital Management
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