Q:  What is the investment philosophy behind the fund? A : The core of our investment philosophy is guided by the belief that we can generate additional return by securities and sector selections and staying neutral to duration. Our bond research capabilities and risk aversion stance gives us the confidence to generate superior risk adjusted returns. We try to find the balance between the interest rate risk and credit quality deterioration risk to generate the optimal risk-adjusted return and still perform like a core bond fund. The two main factors that we consider for this fund are income and stability of principal. Q:  How would you describe your investment process? A : By trying to get the right balance of risk-adjusted returns, we seek to have a broadly diversified fund that contains U.S. Treasuries, mortgage securities and bonds issued by the U.S. government agencies. Our primary strategy aims at outperforming the index with the help of corporate bonds. Our investment process is driven by bottom-up security selection that can generate returns that are above the benchmark index. The bulk of the corporate bonds that we buy are in the BBB and BB ratings, and we think that strategy gives us the best risk-adjusted returns within corporate bonds. In our view, going down to BBB rated bonds gives us the best mix of income and cushion against rising interest rates, whereas BB bonds are a very attractive opportunity in corporate bonds because they represent the least sponsored part of the bond market. Our analysts focus on that segment of the market to uncover the BB rated bonds that we think are candidates for upgrade to investment grade. We gain the benefit of not taking a lot of credit risk because we are buying what we think are already investment grade companies. We get more yield and price appreciation when these BB rated companies get upgraded to investment grade. That crossover trade or bond rating revision is an important part of our strategy which helps us in delivering above average risk-adjusted returns. The key for us is finding a company that has a dominant market share, generates steady or stable free cash flow, operates in a defensive industry and has a focus on paying down debt. Q:  What is your research process? A : Our research process is driven by analysts who generate ideas by staying involved in both credit and valuation decisions and being able to make recommendations about what is added or taken out of the portfolio. We believe that an investment approach based on collaborating with analysts and functioning as a team lends to better decisions. At the end of the day, it is always the portfolio manager that has the full veto power. While the analysts do not have the ability to add a name to the portfolio on their own, they certainly drive the process of getting new ideas into the portfolio. At the same time, the portfolio manager’s role is to understand the risk tolerance of the fund, recognize that individual security trades are part of the holistic portfolio, and make sure that the risks are being allocated properly to meet the goal of being a core bond fund, focused on principal protection. The key benefit we have is that we are not only part of a large research organization but we are also small and nimble enough to take advantage of our equity analysis ideas. Q:  What differentiates the fund from its peers? A : One of the main advantages of MFS is how we collaborate within the firm in terms of the integration of both fixed income and equities. Another unique aspect of the company is our global research platform with equity analysts in Boston, Hong Kong, London, Mexico City, Sao Paolo, Singapore, Sydney, Tokyo, and Toronto. We have weekly global sector team meetings where all the analysts assigned to a specific sector will get together via teleconferencing to talk about themes. For example, the sector team would include energy analysts who happen to be in U.S., Asia or Europe together with a high grade bond energy analyst sharing ideas, collaborating and coming up with best ideas. We do not necessarily buy all the same securities, but we do share industry themes throughout the sectors, which is a significant advantage. What I find extremely important as a bond manager is the ability to gain additional access to interesting bonds or securities through our equities group. Although bond managers do not typically have access to CEOs and CFOs, when a company is here to meet with our equity team we have an opportunity to listen and meet on a regular basis with the decision makers. For example, when representatives of The Kroger Co., the largest independent grocery retailer, were in the office a while back, we had a very productive meeting. The day after that meeting one of their competitors announced a shortfall in margins, pricing was getting squeezed and the stock was down 12% for the competitor, which caused bond prices to fall across all supermarket companies. Given the fact that we had just met with The Kroger Co., we had a very high conviction that the margin weakening story does not apply to the company. We were able to recommend adding to the bonds because we thought that the decline was unwarranted and what had happened to the competitor would not apply to Kroger. Q:  How do you evaluate different investment opportunities? A : Tyson Foods, Inc. is a classic example of how a company that was investment grade lost its status only to return to investment grade again. In the early 2000s, Tyson was a 100% chicken food company and its bonds were A rated. Then, Tyson decided that it wanted to diversify strategically into beef and pork, so it borrowed money to make an acquisition of the nation's largest beef producer. Consequently, the company took a hit on its debt and the rating was downgraded to BBB. The timing of that could not have been worse because shortly after the beef acquisition the mad cow disease fears were widespread in the market, dragging the margins and forcing buyers in Asia to stop importing American beef. Tyson was in a tight corner after the purchase and now had higher leverage on its balance sheet as the newly acquired business was bleeding. Soon afterwards its core chicken business was also hurt due to fears related to avian flu in Asia. In addition, in 2008, oil prices spiked and farmers switched to growing corn for ethanol as a fuel additive from growing grains for feedstock, which sent prices for chicken feedstock through the roof affecting the company margins. Within a short period of time the rating agencies started downgrading the company debt after the toxic mix of high debt, falling margins in the core business and quarterly cash flows were likely to drop below the requirements of financial covenants entered at the time of the beef acquisition. In the end, rating agencies downgraded Tyson below investment grade to BB. That lifecycle illustrates how a single A company can end up having a BB rating. Then, over a period of time, grain prices dropped to normal levels and as the beef demand and prices recovered, we started looking at this company after it had been upgraded from BB to BB+. As oil price eased and margins normalized, prices for Tyson’s food products returned to normal and the company generated a billion dollars of free cash flow from 2009 to 2010, with every penny of that going to pay down debt. The company had always been investment grade, wanted to be investment grade and took steps to do that when the cash flow improved. All in all, Tyson had real commitment to returning to investment grade. What really attracted our attention was that in a conference call in early 2011, the company’s CEO said that they would get their investment grade rating back. And that happens very rarely on quarterly earnings call. The announcement gave us a lot of conviction to buy the bonds that the management team was so focused on, and not long after that the bonds were upgraded to investment grade. Additionally, we tend to focus on emerging markets, especially on companies with improving fundamentals that are based in countries appealing to our sovereign analysts. For example, we like Brazil because credit and business fundamentals are steadily improving. We do not own the sovereign debt because the yield is too low and we think we are not getting compensated enough. Instead, we will buy some of the national champion companies from Brazil such as Vale S.A., the largest mining company in the nation. Vale has got size, cash flow and credit metrics similar to Australia-based BHP Billiton or Rio Tinto Plc. Our belief is that we will benefit as Brazil continues to get upgraded and bonds of Vale will increase in value respectively. We can generally win in two ways – we get more yields while we wait; and as spread tightens on the back of Brazil’s improved rating, the value of the Vale bond will be driven higher. Q:  Do you focus on macroeconomic factors? A : Economic prospects controlled by political processes are extremely difficult to forecast. We recognize that we may have a negative view on the economic outlook, but that can change on a dime and our portfolios can get affected if a central bank announces to offer stimulus packages of billions of dollars. Such a move can cause the market to swing the other way in an instant. Bearing that in mind, we strive to maintain a balanced approach to our view on the economy. We recognize that if we position the portfolio to an extreme, we might expose the portfolio to a lot of volatility. Our goal is to add value via superior security selection over time. Forecasting economic outlook is difficult enough, and to decipher political outlook on top of that adds even more uncertainty. Our way of limiting the unpredictable outcomes is by investing in U.S. dollar bonds only without taking currency bets because we think currencies tend to be exceptionally volatile and highly correlated with equities. In fact, being loaded up with currencies that are highly correlated with equities defeats the purpose of a bond portfolio aiming to provide diversification from an equity portfolio in the first place. We do not invest in derivatives either, primarily because they introduce additional basis risk that we prefer not to have. Q:  Is your portfolio fully invested? A : We will occasionally allow cash to rise, but usually to no more than 5%. We are fully invested most of the time and our job is to deliver the returns available through our strategy and sector rather than hide in cash. The way we control our risk budget is by managing the spread duration we have primarily in corporate bonds, and we will whittle down and swap out of the riskier corporate bonds into the appropriate Treasury because we are duration neutral. Cash is not the residual and we do not sell and go into cash, as that would cause the duration to fluctuate. If we sell a corporate bond, then we park the proceeds in U.S. Treasuries if we do not have another corporate bond to buy. For us, the Treasuries are the residual in the risk budgeting process. Our job is not to forecast interest rates but to add value through security selection and make sure that we are protecting investors and staying true to our philosophy. If we were to go to cash we would miss out on a lot of appreciation. Q:  How do you build your portfolio? A : Presently, we have 500 names in the portfolio, the majority of which are individual securities from different mortgage-backed pools. Typically we will hold anywhere from 150 to 200 corporate bonds, supplemented with mortgages, Treasuries and bonds of agencies. For a corporate bond, a position size would be anywhere from 25 to 50 basis points. Typically, it is a 25 basis points weight for a high yield bond and 50 basis points for a high grade issuer. Q:  What is your buy-and-sell discipline? A : Having thoroughly researched an idea, we will make a swap if the name seems to be yielding attractive spread for its quality, and the yield is superior to something else that is currently in the portfolio. We will also take into account the bid-ask spread for transaction cost to determine whether it still offers attractive value. At the same time, we may consider selling a portfolio holding primarily for two reasons. First, if spreads have tightened to the point where the security is no longer offering any better value than Treasuries and it is not providing much of a cushion to help the portfolio, we will swap out of these names to replace them with new plays that have wider spreads with credits that we think are comparable but offer more attractive pricing. Another reason to sell would be that the credit thesis is breaking down. Typically, when we underwrite a name to go into the portfolio, our analyst will forecast at least the next two years going forward. The main advantage of this approach is that we can stress test those names to see if they can withstand different economic environments. However, if the environment is deteriorating and the stock or bond price is weakening, the analyst may take another look at the original thesis to verify if the thesis is holding or breaking down. If a credit is deteriorating, we tend to prefer to get out of it and replace it with something else. Q:  What kind of risks do you focus on? How do you mitigate risk in the portfolio? A : For us, the biggest risk is going to be spread widening risk in corporate bonds. We think that corporate bonds offer a good risk-adjusted opportunity compared to Treasuries, but we know that during market dislocations spreads would widen. Our goal is to monitor the risk budgeting and recognize that corporate bonds will underperform Treasury bonds during risk-off periods. That is the reason why we go into Treasuries. Risk budgeting is another area where we will have a certain amount of risk that we want to take in the portfolio and it is up to us to budget how we get there and spread among the different sectors. At our monthly risk and opportunities meetings, the portfolio managers present the sectors that they specialize in and discuss where they think the opportunities lie on a risk-adjusted basis. Also, every day we have a morning meeting which is primarily run by our chief economist, who will present news from overnight. We have the opportunity to talk about large macro factors and their possible impact on risk budgeting. Our bottom-up process also contributes to the risk budgeting process by providing real time feedback from the senior management teams of the companies that we own. All in all, what we are doing is a balancing act between spread product, (e.g. corporate bonds) and Treasuries as the risk environment changes. Our goal is to deliver positive returns even during periods of market dislocations, so one of the ways of finding that balance is by monitoring the peer group, scouring hundreds of names in the category and understanding how they are positioned. As we go along, we want to make sure that we are not migrating too far into the extreme ends of risk scenarios from a relative basis. We tend to stay down the middle and add value through superior security selection and our rigorous research process.