Q:  What is the investment philosophy of the fund? A: We differ from most high yield bond managers in the sense that we manage our portfolios with an eye toward mistake avoidance. As high risk bond investors, we know that over time the majority of the return comes from the coupon. At the end of the day you're entitled to your interest payments and your principle back. With the exception of short periods of time, like 2003 and 2004, the capital return in high yield is often negative and the income return is positive. So we drive our management process with the knowledge and the expectations that minimizing losses is the driver of long-term outperformance. In general, we don't really have the ability to create the home runs that offset mistakes, so we don't seek out home runs, but mistake avoidance. We do that through a very disciplined process with the understanding that we're at the riskiest part of the credit market and therefore there will be some mistakes. Our methodology is set to minimize them. Q:  How would you define the strategy of the fund? A:We are a fundamental shop with a bottom-up approach to credit selection. We're effectively a duration-neutral manager; duration is a by-product of the process. We try to keep duration in line with the Lehman Brothers High Yield Index and we're not trying to project interest rates. What we're trying to do is pick good credits. The whole process revolves around relative value at the credit level, which boils up to sector exposures, which we manage within a tolerance. The portfolio holdings are populated by credit selection, with an overlay at the industry level. The duration of the portfolio falls out from that. We are cognizant of the need to stay in line with the index and therefore, when we can and want to, we'll actively manage duration in two ways. We'll buy a higher coupon, higher dollar price bond at the short end of the curve for interest income generation. When we identify a credit with significantly improving fundamentals, we'll extend out into longer duration paper so that we get the most performance for our dollar when the spread compresses. But other than that, it's a credit selection process, not an interest rate bet. Duration will only tell you the mathematical equivalent of a spread widening, but it won't help you define deterioration in the credit. We're more inclined to identify the names where we see fundamental improvement and therefore would expect to see spread tightening versus deteriorating credits where you actually see dollar point declines. Q:  Do you mostly invest in U.S. corporate debt offerings or do you consider other opportunities, such as the emerging markets? A: We think of ourselves as global credit investors. The exposure in the highyield portfolio is primarily dollar-denominated domestic debt, but we do have a small European high-yield portfolio that invests in Euro- and Sterling-denominated securities of issuers outside the U.S. When those names offer good value, they will find their way into our domestic high yield portfolios. The High Yield Opportunities portfolio has a dedicated exposure to emerging markets, which is between 15% and 20% of total assets. We allocate that money to Matt Ryan, our emerging market portfolio manager, who makes the sovereign debt decisions within the portfolio. Any time we take a corporate exposure within emerging markets, it's driven by a positive sovereign view to begin with. Our credit analysts work in tandem with our emerging market analysts to make a decision regarding credit quality. Q:  How is your research process organized? A: Within the group we have seven full-time high-yield credit analysts who are experts in their areas of coverage with average experience of over eight years. We have two full-time fixed portfolio managers, Scott Richards and myself. We also have two full-time high yield traders, who are an important part of our process, keeping us up to date on the technicals in the marketplace and general news flow. We're not very active traders, but because the high yield market is technically driven at periods in time, we need an upto- date assessment on what's going on in the market. Knowing the trends, the fund flows, the new issues and news developments, helps us think about relative value on a longer-term time horizon. But the core of the process remains our research capability. We also have a bank loan portfolio manager for a new product that we launched at the beginning of 2005. Our analysts look at both bank deals and bond deals. They look at equity, because we need to look at the entire capital structure to find the best investment opportunities. We also want to know the structure of the senior debt, so the bank loan portfolio was a natural extension of our process. The added benefit is that we see the bank deals, which we would expect over time to overlap about 85% with public bond issuance. Those bank deals come through the market before the bond deals and tend to have a more detailed bankbook, which is compiled public data that's been screened by outside counsel. So we're seeing much more granularity and getting a preview of many of the deals that later come to our market. Q:  How do you monitor the various sector exposures within the portfolio? Being a bottom-up investor, do you still have a macro view? A: We start from the bottom up and let the population of each sector evolve based on how many credits within that sector we identify as investment opportunities. For example, in a sector like oil and gas, which we have liked for a number of years, there is a constant drumbeat of analysts recommending these companies. As that theme continues to be stated, we've already naturally identified how we want to be weighted in that industry. Then it's a matter of optimizing the exposure. In the case of very volatile sectors, we try not to be more than 10% to 15% overweight relative to the index. In less volatile sectors, such as oil and gas, we can bring that exposure up significantly more. Since our goal is to drive performance through credit selection, we don't want an explicit or implicit sector bet to overshadow that performance. That being said, today there are four sectors in the market where we're meaningfully overweight and three sectors where we're meaningfully underweight. The broader segment is effectively neutral. Q:  What have you learned from your experience, from the mistakes that every fund manager makes? How have you adjusted your strategy over the years? A: Back in late 2002 and early 2003, the high yield utilities space went from about 3% of the Lehman Brothers High Yield Index to over 16%. That was driven by Enron, Williams, and Dynegy, among others, which were investment-grade credits that tumbled into the high yield market and overwhelmed the credit market. It was a dramatic dislocation, where fallen angels were a huge piece of the high yield market, both in telecom and utilities. We were hurt by that phenomenon because we weren't in any dramatic rush to take our exposure up to 16%, which was its representative size in the index. We went though credit by credit very methodically, identifying undervalued opportunities with intact fundamentals and offering good value. We ended up buying investment grade credits like TXU, secured paper trading at 80 cents on the dollar. The problem with the strategy of mistake avoidance was that we didn't get involved in a lot of names, like Calpine, Dynegy and Williams, which were on the brink of bankruptcy and were rescued by a recovery in the capital market. It was very difficult for us to come into a credit that we saw as severely distressed just because it was big in the index. Q:  Can you give us an example of a successful long-term investment in a beaten-up industry? A: Back in 1998 we invested in Lyondell Chemical, which came through the high yield market to refinance a loan when they bought out Arco Chemical. At that point, we were close to a peak in the commodity chemical cycle. Our equity analyst was very bearish on commodity chemicals, while I saw a huge opportunity after getting to know the company. We ended up buying the bank debt, the senior debt, and the subordinated debt. From that point on, we've have made tons of money and we still own the name. Lyondell did impress me because they had a significant fear of debt. They were humbled by making an acquisition at the top of the market, which the equity market perceived as crazy. They were staring down the barrel of a loaded gun in terms of new ethylene capacity, which would annihilate their margins. They had a product that was going to go away and that was effectively priced into the bonds. Those bonds now are trading at a relatively tight spread and will ultimately be refinanced. They never cut the dividend on the stock and paid down debt with every ounce of excess cash flow. They're still a very well run organization and are doing great in spite of everything that happened in the commodity business. One could have easily dismissed them as a dinosaur eight years ago and would have missed a great opportunity. Q:  What led you to believe that Lyondell had the ability to deliver the cash needed to pay the interest and the principle back? A: When I was in Houston visiting with the company, the fear of debt permeated the entire organization. Operating guys, who were scraping for capex dollars, were met with very stiff resistance unless the rates of return exceeded what we felt were significant hurdles. The other benefit we saw was their intent to de-lever. Their bank debt was structured with a significant amount of pre-payable debt. From the very beginning they started taking down debt with excess cash, so the commitment was real and legitimate. Another comforting thing was their commitment to pay the dividend on the equity, which would be very foolish unless they knew that they could do it. Everything that we saw in that management team was consistency, which is one of the most important things for us. Q:  How many positions do you have and what diversification do you employ? A: We feel that there's no value in concentration. Currently, we have about 395 different securities from about 300 different issuers. Emerging markets are about 17% of the portfolio. At least two-thirds of that tends to be in sovereigns and one-third is in corporates. We're trying to isolate liquidity and term structure because value can be found within many capital structures. For example, in names such as Quest, we have ultra-high premium 13.5% coupon bonds and we have lower coupon discount bonds that were issued as investment grade paper. We try not to worry about the issue count, but about finding stability in the portfolio. We are driven by income generation, so we are looking for solid current income without a lot of volatility. We optimize how much performance we can generate through spread compression where we can isolate it. Q:  What kind of risks do you perceive and how do you monitor and manage them? A: In terms of the general risks, we use a number of different analytical tools. We have quarterly industry reviews with the portfolio managers and the analysts for every sector. This is as much part of our credit selection process as part of our risk management process. We look not only at what we own, but also at the issues in the Lehman index. Usually there are only one or two fine-tuning type of trades that come out of that process. We're acting with a long-term investment thesis in mind, but we react to developments in the market as they come. We don't generate a significant amount of turnover; it's between 65% and 70% for the year. If only two trades come out of an industry review, that means that we've been properly communicating with the analysts and the trading desk throughout the quarter, so there aren't any dramatic shifts to be made.