Q:  What kind of bonds do you invest in your fund and what is the size of the high yield market? A : The High Yield Fund seeks a high level of income by investing at least 80% of the portfolio in lower rated corporate bonds with ratings of BB or below as rated by the rating agencies. This universe of bonds are generally rated BB, B, and CCC, or below. The high yield bond market is roughly around a trillion dollars and there is about 1,600 bond issuers. The universe of issuers is very diverse and broad, ranging from airlines to cable TV network operators to telecom companies, which tend to have fixed assets generating some kind of predictable cash flow. Q:  Who are the issuers of high yield bonds? A : In general, companies that have a need for substantial capital and that can generate predictable cash flows to support the higher amount of debt on their balance sheets. Cable and telecom companies that have high capital expenditures have tended to be large issuers. Sometimes, struggling companies like Ford Motor Company or General Motors will get downgraded and their debt will fall into the high yield arena. In addition, stable companies that are experiencing slow growth may also issue such bonds in order to have more leverage to enhance their equity returns. Also, when a company is acquired by a financial sponsor or another company, they may come to the high yield market to get the required financing for their acquisition. Q:  How would you define the objective of your fund? A : The fund seeks high current income and, secondarily, growth of capital.. We seek to outperform our benchmark Barclays High Yield Index and our peers in the mutual fund industry. Q:  What is your investment process? A : Generally, we focus on B and BB rated bonds and we systematically underweight the higher risk CCC rated securities to minimize the downside risk. The bonds rated CCC are issued by companies that have high leverage on their balance sheets and have a greater chance of default. Higher quality, BB rated bonds, tend to trade up or down with interest rate movements, while CCC rated bonds behave more like equities. Bonds that are B rated are a mix between these two extremes. This is where we focus our attention. Q:  Do you ever look at CCC rated securities? A : Even though the risk/return characteristics of CCC-rated bonds are not attractive over the long-term, we do hold these for shorter periods of time as we did last year. In fact, last year the CCC rated bonds as a group gave us a return of 100%, whereas the B and BB rated bonds returned 45%, but of course their risk levels are much lower. We generally like to buy CCC rated bonds when they are trading below par and sell them when they trade above par. Q:  How do you go about your selection of positions? A : We start with a top-down approach by estimating the direction of the economy with the help of several econometric models to determine the likely course of the economy. This helps us determine the overall level of risk we want to take and how we want to be positioned among the bond rating categories. Then with the input from our team of six industry analysts we seek to determine what industries we want to be in and how we want to be positioned in those industries. The positioning is based on bond ratings and the yields of those bonds that we are looking to invest in. Our goal is to build a portfolio of bonds that will outperform given our economic outlook. At times when we are positive on the economy we are prepared to take more risk in the portfolio compared to the benchmark holdings, and when our view is negative we take a defensive approach as we did in 2008. Generally, we look for companies that have positive free cash flow, which means that they are generating enough cash to pay down debt in order to lower the amount of leverage on their balance sheets. Hopefully, some companies that start as a high yield bond issuer and pay down debt with free cash flow will improve their rating to investment grade. We also look for companies that have access to the capital markets and could issue debt or equity for additional or alternative sources of liquidity. We check loan and bond covenants and the company’s access to revolving credit to determine their capacity to repay their debt maturities. Finally, we look at the asset coverage so that, in case the firm defaults, we can recover a significant portion of our investment. We will consider all these factors before taking a position in any bond. Q:  Would you give us some examples to illustrate the process? A : An example of one of our typical larger holdings is HCA. It is a leverage buyout done several years ago of a large hospital company with close to $30 billion in revenue. The hospital business is relatively stable and predictable and the company produces over $1 billion in yearly free cash flow to reduce debt. We hold a position in the second lien notes rated B2/BB- that has produced an annualized return of about 10% over the last several years. Another example of a high yield investment we would hold is Ford Motor Credit. Although the auto company was struggling and not producing free cash flow, we felt comfortable that asset value backing the debt of Ford Motor Credit Company was solid. These bonds have risen from a price of around $50 to about $100 over the past year. Q:  How do you identify which bonds will survive and do well? A : Every bond that we evaluate for investment undergoes scenario testing. Our goal is to determine whether under various economic conditions the companies will still have enough cash flow to pay for interest and other expenses. If the cash flow is satisfactory and meets our estimates of the required cash, we assume that the bonds will retain their value. This kind of analysis provides us the downside protection that we are looking for. Q:  How many names do you hold in the portfolio and how do you manage your buy discipline to keep its high yield nature? A : We typically have between 150 and 180 names, which gives us sufficient diversification to help minimize the downside risk. By focusing our investment on below investment grade bonds, we will have a higher yield than higher quality investment grade funds. In general, the yield of our portfolio is within 20% above or below the benchmark yield. This range provides us the leeway to overweight or underweight different bonds and industry sectors depending our view of the economy and industries while providing our shareholders a core high yield experience. Q:  How do you control the industry exposure? A : We tend to keep the industry exposure to no more than plus or minus 5% of the benchmark weights. Also, we never have more than 15% of the portfolio weighting in any one industry, but, as far as bond duration and interest rate risks are concerned, we try to stay neutral to our benchmark. Q:  Do you also invest outside of the high yield market? A : We may sometimes invest outside of the high yield market in instruments such as bank loans which have floating interest rates or convertible bonds which can provide returns that are similar to CCC rated bonds without the illiquidity. Yet, we limit these investments to a small portion of the portfolio. Q:  How would you describe your sell discipline? A : We will sell a position if the company has violated one of the critical expectations we had when we made the investment. On the other hand, if a bond has performed well and met expectations, but appears to have limited upside, we will sell the bond and reinvest the proceeds into a bond that has more room for improvement. We may also trade bonds when our economic or industry view has changed and we need to reposition the fund. Q:  What is the portfolio turnover? A : It tends to be between 50% and 75%. Q:  How do you perceive risks in your fund and what do you do to mitigate them? A : The biggest risk in this market is that of default so we try to mitigate it either by being underweight in the CCC rated bonds, or by avoiding those that have a riskier credit profile. For instance, last year the high yield market had a default rate of 12.9%, the vast majority of these defaults were from bonds rated CCC. By having less exposure to the CCC rated bonds we have been able to have less volatility than the benchmark. In addition, being senior or secured in riskier credits also helps minimize volatility and maximize recovery in the event of a default.