Keeping Things Flexible

Another holding, cable television provider Charter Communications, became part of the portfolio last year after concerns about poor management and excessive debt brought the stock’s price down. Under new management, the company has ramped up free cash flow, which it plans to use for share repurchases and reducing debt. Osterweis, who says Charter is cheap compared with other cable TV providers, estimates that free cash flow will come in at about $7.50 per share in 2015 and believes it will more than double in the 2016-2017 period.

One of the highest income-generating stocks in the portfolio is real estate investment trust Digital Realty, which specializes in offsite corporate data and computing centers. Osterweis bought the stock in early 2014 when the price dropped over investor concerns about overbuilding in this sector of the market. At the time, it was yielding a juicy 8%. “The interesting thing about Digital is that it uses 10-year leases with built-in rent escalation clauses of 2% to 3% a year,” he says. “Eventually, all the dumb money entering this market will be absorbed. And instead of lowering its payout, as many investors feared, the company has raised it.”

On the fixed-income side, the short-term, high-yield bonds that populate that part of the portfolio must have some defensive characteristics that offset their below-investment-grade credit ratings. One of those characteristics is that, unlike long-term bonds, companies often have the cash waiting in the wings to pay off short-term debt that’s coming due soon. To Kaufman, “this means their actual credit risk is less than the company’s credit rating might imply.”

Examples of what he considers low-risk securities in the bond side of the portfolio include Rite Aid’s 9.25% coupon bonds maturing in 2020. The bonds, which have call protection until March 2016, have a yield-to-call of 5%. Kaufman cites it as “a company with $25 billion in revenue and lots of free cash flow that’s being used to bring down leverage.”

Another bond position, crafts purveyor Michaels Stores, has a coupon of 7.5% and matures in 2018. Although the bonds are currently callable at 102, Kaufman says the company is unlikely to redeem until August 2015, when the call price drops to 101. In the meantime, the fund reaps a yield of over 6% until August. And 8.75% coupon bonds of steel distributor and producer Edgen Murray maturing in 2020 are priced to yield 4% and can’t be called until November 2015. They also have an added layer of protection from Japanese conglomerate Sumitomo, which acquired Edgen Murray in 2013 and would likely step in if the company were to have trouble paying the debt.