Manager Commentary
Portfolio Manager
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Mary Austin, CFA has been with the Pax World High Yield Fund since its inception in 1999. She has been Portfolio Manager since December 2005. Prior to joining Pax World, Ms. Austin worked for Salomon Smith Barney for eight years. Her last position was as an equity analyst covering small- to mid-cap specialty pharmaceutical and medical technology companies. Prior to that, she assisted in coverage of large-cap pharmaceutical companies. Ms. Austin has a bachelor's degree in Public Accounting from Pace University and became a Chartered Financial Analyst in 2003. She is a member of the New York Society of Security Analysts, its Socially Responsible Investing Committee, and the Association of Investment Management and Research.
Management Style
The Fund invests primarily in high-yield, fixed-income securities commonly referred to as “junk bonds” and rated below BBB- by Standard & Poor’s Ratings Group or below Baa3 by Moody’s Investors Service, or unrated securities of comparable quality. The Fund can invest in convertible bonds, preferred stocks, zero-coupon, pay-in-kind, deferred-payment, and other high-yielding securities. Up to 40% of the Fund can be invested in high-yielding debt and equity securities of foreign issuers. In-house research looks closely at the financial history and condition, cash flow trends, analysts’ recommendations, and management of each issue considered.
The Fund seeks securities issued by companies in more economically stable industries or in higher-growth sectors. At times, the Fund may hold large amounts of high-quality cash instruments. When deciding on how much cash to hold, the Fund looks at the anticipated direction of domestic interest rates, the global economic outlook, and their anticipated effect on the high-yield market.
Portfolio Commentary (as of March 31, 2008)
The turmoil in the credit markets that began last summer continued into the first quarter of 2008, climaxing with the proposed bailout of investment house Bear Stearns. The firm’s problems started in July with its own internal bailout of two of its hedge funds. By March 2008, the firm was suffering severe financial losses due to customer withdrawals. On March 16, JPMorgan (0.0%*), in a government backed buyout, bid $2 a share for Bear, a company that had been trading at about $120 only six months prior.
Many feared that other investment banks with significant mortgage debt exposure would face the same fate. The Fed stepped in immediately and opened the discount window to broker/dealers in an effort to stabilize and provide additional liquidity in the markets. The Fed also lowered the discount-lending rate by 25 basis points (bps) on March 16, two days before its scheduled meeting, and then lowered the federal funds target rate by an 75 bps March 18.
High yield spreads that had widened approximately 250 bps from year-end to 842 bps contracted by about 45 bps after the Bear takeover was announced.
For the quarter, the Pax World High Yield Fund total return was negative 1.80% and negative 1.75% for the retail and institutional class, respectively, placing them in the top 6% and top 5%, respectively, versus the Lipper High Yield Current Bond Index, which posted a negative return of 3.50%.
The current tone of the market is improving. Fear has been mitigated somewhat by the Fed’s actions and willingness to take whatever action necessary to restore stability in the markets. The economy may start to pick up later this year as the lower federal funds target rate should start to positively impact consumer sentiment and spending.
Nevertheless, in the near term we expect continued volatility in the high yield market. Second and possibly third quarter 2008 earnings are expected to be weak due to the consumer slowdown. Defaults have picked up and in the first quarter alone have already exceeded last year’s annual total of $3 billion.
Due to our outlook, we increased the defensive holdings in our portfolio in the first quarter. We added to our existing positions in the telecom and healthcare sectors and increased our exposure to commodities. We participated in the new issues of Fairpoint Communications (1.0%*), an integrated telecom operator, and Axcan (1.2%*), a pharmaceutical company that treats gastrointestinal diseases. We increased our positions in foreign telecom companies Millicom (2.1%*) and City Telecom (1.4*),as well as in Hangar Orthopedic Group (1.5%*), a healthcare services provider and supplier of orthotics and prosthetics.
Believing that increased demand for commodities around the world will continue, we purchased the PowerShares DB Agricultural Fund (ETF) (1.5%*). This position provides the Fund with exposure to the agriculture sector. We initiated a small position in the PowerShares U.S. Dollar Index Bullish Fund (ETF) (0.7%*). Our view is that the dollar will slowly rebound against other currencies as the world economy slows and other developed nations lower interest rates.
Two companies we sold from the portfolio over the quarter are Aventine, an ethanol company, in the belief that it may experience liquidity issues later this year and Copano Energy.
This commentary does not constitute an endorsement of any company’s attractiveness as an investment.
*Portfolio holdings as of 3/31/08.