Q:  What is the history of the fund?   A : The fund dates back 10 years when it started as a private collective trust fund for the trust customers of Frost National Bank. We converted the trust to a total return bond mutual fund two years back, in April of 2008. The fund is managed by Frost Investment Advisors, LLC, formed in December of 2007. The historical data of the fund before 2008 will relate to the private trust fund’s performance. There haven’t been many changes to the fund from the collective trust fund days. The investment advisor manages about $1.95 billion in mutual fund assets, included in the total of about $6.5 billion of assets under management, as of June 30, 2010.   In addition to the Total Return fund we manage three other fixed-income mutual funds, combining the day-to-day responsibilities of managing our mutual funds with our efforts to set investment strategy for the adviser in general.   Frost Investment Advisors is a wholly-owned, non-banking, subsidiary of The Frost National Bank, which was founded in 1868.   Q:  What core beliefs guide your investment objective and philosophy?   A : The fund seeks to maximize total return, defined as income generation and capital appreciation. To achieve this objective the fund invests in a diversified portfolio of fixed income securities, including U.S. government debt, corporate bonds, mortgage-backed and other securitized bonds and municipal bonds.   The fund focuses primarily on investment grade securities and does not use futures, options or leveraged type strategies.   We actively manage the duration of the portfolio with a view to maximize performance. The average duration of securities typically stays within plus or minus 3 years of benchmark duration, but the team can vary our position based on our macro views.   Q:  What is your benchmark index for this fund?   A : We use the Barclays Capital U.S. Aggregate Bond Index as our benchmark. It represents securities that are SEC-registered, dollar-denominated and taxable.   Q:  How does your philosophy translate into the investment strategy?   A : The Frost Total Return strategy aims to offer capital growth with an actively managed portfolio allocating between domestic fixed income securities, bonds and alternative assets. The fund has an emphasis on capital preservation. This diversified approach, combined with investment in some less correlated assets, results in significantly lower portfolio volatility.   Q:  How do you approach your investment strategy?   A : We look for value opportunities, using both a top-down analysis as well as the bottom-up, or individual asset, assessment. We concentrate only on what we do best and we don’t deviate from that focus. This means we do not spend a lot of time in the area of convertible bonds or the preferreds sector, assets you will not find in our fund.   The fund has a long-term investment horizon with a focus on the character of the intermediate part of the yield curve. We believe this strategic focus helps us manage our long-term return, while reducing the impact of changes in the short or intermediate market.   We are active managers, so we may deviate from this intermediate focus, especially with respect to interest rate, resulting in the fund actually looking more like a short maturity portfolio. Because we are managing a domestic portfolio we don’t have any currency risk in this fund. Our experience over the years has given us expertise in the credit sector and the securitization sector, which would cover areas like mortgage-backed securities and asset-backed securities. Consequently, a lot of our strategy will revolve around those two areas, securitized bonds and credit.   With this fund we are as transparent as we can be. This means we do not use any leverage in the fund, which explains why we do not have derivatives, futures, options, convertible bonds or credit default swaps in our fund. We are a 100% cash bond fund, reflecting the way we have worked from our pre-mutual fund days.   Q:  What are the various steps in your research process to achieve this strategy?   A : We have an investment team made up of two senior portfolio managers (including me), two senior credit analysts, two traders, and one junior analyst..   In addition to our team based analysis, we participate in the general strategy developed by the adviser, cooperating with the adviser’s equity analysts and chief research strategist. Frost Investment Advisors has an investment committee that provides general strategy for  all of the assets and strategies managed by the investment adviser. This committee consists of 10 people, including our Chief Investment Officer and me. The committee is not involved in the day-to-day business of the fund but helps us with our view of the U.S. economy vis-à-vis the global economy, and the direction of the financial markets, whether its applied to bonds or stocks.   The Fixed Income team focuses on four fundamental elements in identifying our strategic goals. First, we determine where we want the duration of the portfolio to be in relation to our benchmark. We use the benchmark to manage risk in our fund, and then forecast expectations around returns in the U.S. bond market.   When we introduce a position in the fund our goal is to hold it at least for a 12-month period. We use the benchmark to forecast where the bond market index is going over the next 12-month period before overweighting or underweighting that position accordingly. Though there is no hard and fast rule on this, we do deviate both in duration and weighting from the index at times.   The second element we focus on strategically is asset type. We look at U.S. treasuries, agency markets, corporate bonds, mortgage-backed securities, asset-backed securities, and municipal bonds.  Each of these delivers a different return based on where we are in the interest rate cycle and where we are in terms of the economic cycle. Based on our analysis of these, we make decisions around which of these we want to be overweight or underweight.   Right now, based on the macro overlay and the modeling we have done, we feel that mortgage-backed securities represent a large amount of relative value, resulting in an overweight position for this area, which can be seen clearly from our holdings currently.   The third factor we take into consideration is credit risk. As mentioned earlier, we have a lot of expertise on credit.  Based on our macro assessment that we are emerging from a recession, we are overweight on the credit side.   In tracking the individual parts of the credit risks we use a tool called option-adjusted spread or OAS. This is one key metric that we look at, giving us a measure of relative value as it relates to credit risk.   Once we have analyzed and determined where we stand on these three variables, an on-going process, we then turn our attention to picking positions and the weighting of those positions. The credit analysts on our team cover each of the securities to determine their performance possibilities, contributing to our decision on the weighting differential asset to asset.   In summation, we make our decisions around the first three variables from a top-down perspective, and then, using a bottom-up view, we pick securities using a combination of our credit analysis and relative value for each security.   Q:  Could you elaborate on your investment process with a few examples?   A : About six months ago we added a new commercial mortgage-backed security issued by Morgan Stanley. This security was composed of a number of real estate mortgages taken throughout the United States. When we started the process, we asked our credit analyst to look into the credit side of the bond. The analyst did the analysis of the 250 odd mortgages that made up this bond, with a model using tools available in the market. When he came to the conclusion that this bond stood a good chance of outperforming the market, we asked the trader in our team to add this position after determining the appropriate weighting.   We recently turned our attention to Transocean, a company that is recently notorious for owning the deep water drilling rig that failed in the Gulf of Mexico, after an equity analyst mooted the idea, saying the stock was trading very cheap. Our credit analyst looked at the name with reference to the oil well leak in the Gulf of Mexico, specifically as to whether the company will be able to repay its debts. The analyst found that even though analysts were not keen on upgrading its stock from a credit perspective anytime soon, the financial position of the company was quite strong, meaning the risk of a downgrade was small. With the credit analyst comfortable with the name, we took a position in Transocean.   Q:  What do you mean by the term “absolute return” in the fund’s name?   A : The name of the fund is actually ‘Total Return’, but, very simply put, we want to deliver positive absolute returns in a total return vehicle. We consider our total return, using interest income and capital appreciation, but we also want our return for at least a year or longer to be positive.   Q:  What would you consider the sources of risk and how do you measure and control them?   A : We use a simple form of Value at Risk, or VaR, developed in-house on the back of over 20 years of historical data, to manage risk. The model helps us to define how much risk we are taking on a day-to-day basis, and helps us to decide our actions based on our macro views of markets, and individual credit sectors. Since our VaR model is re-run daily, based on the three key metrics described earlier for our selection, we always have an estimate of how much risk we have in the portfolio, namely based on interest rates, credit risk, and asset types.   As a second method of risk control we also look at interest rate duration and option adjusted spread relative to credit risk, in order to estimate on a daily basis how much we are yield curve risk we are maintaining in the portfolio.