Q: The last losing year for this fund was in 1994. Bond prices are now at all-time highs. Can you still make a good case for them? A: Basically, what I tell brokers at this point in time, when rates are at 40-year lows on the 10-year Treasury, 30-year lows on the two-year Treasury and Fed funds at the lowest we've seen since the Eisenhower administration, why would you possibly want to buy a bond? The rationale is that things other than a government security will do well as the economy recovers and rates begin to rise. This is sort of counter intuitive. Everybody seems to think if rates rise they lose in a bond fund. It is right when you are in a $30 billion fund that is heavily laden with Treasuries. It is right if you are in an intermediate or long duration Treasury fund. It is right if you are in a Ginnie Mae fund. It is not right if you are in a fund that invests primarily in things other than Treasuries and Ginnie Maes. That is my number one lead-in. The big thing I'm hearing now is if I want a bond in this environment, I have to buy high yield. It is sort of a rear view mirror investing tactic. Having earned a coupon in four of the last five years in high yield, now we've had a 27% run since October of last year and we need to jump on the bandwagon. Q: Isn't that chasing performance? A: The unfortunate thing is even some of the strategists are saying, 'Buy high yield.' What I try to cover in a market overview is the problem of corporate supply in this bifurcated market. The bonds that people want to own in high yield only give them a 6% to 9% yield. That is four-fifths of the market. Then there is that other 1% of the market that really had the biggest move over the last seven months and generated 50% returns. Q: Those bonds normally have the lowest credit quality ratings. A: The junk of the junk generated those returns; the stuff that you don’t want to own that is way ahead of fundamentals, or driven by technicals, or just the demand not only from mutual funds but also insurance companies and pension plans that can't pay their benefits or can’t meet their dividends. They can't live off 3% Treasuries. They need yield. Q: Didn't they assume a lot of risk? A: A massive risk. Now, it looks like it's smart to time the equity markets. You can get in before it goes up and out before it goes down. If you can time the high yield market and the high risk, all the power to you. But, that adds a degree of volatility and also the potential for a surprise to shareholders. I just don't think it is appropriate. Q: A large corporation or government sponsored pension fund would definitely have a problem finding a liquid market when they are ready to sell. A: That is it in a nutshell. Liquidity is just not there for size. Based on the size of our product, it really helps us in terms of maneuverability. It is a huge advantage. I can tell you until I'm blue in the face how great we are. But, if you are a broker and you screen a product, you set up criterion. Your screens are for tenure of management, quality, diversification, historical performance and Lipper. You can't do better than us. We're A2 credit quality. We have 212 issues. I've been with the fund for over 10 years. When you talk to people and they say, ‘gee, you've only been around for 10; I've been with the firm for 22 years.’ The average bond fund manager right now is 27 years old with two and a half years experience. Q: Fund watchers don't know what the long-term performance will be for the newer products, but we do know your fund has only seen one down year in the last 10. A: The nice thing about having one down year is, yes, we made some mistakes. But, what did we learn from it and how did we move on? What we learned were three quite simple facts that now play into our strategy. Number one, you need smaller position sizes. Smaller position sizes alleviate your tendency to be emotional about credit management. In other words, my buddy's father works at GM, I love GM, I have a 4% position. Once it goes down, you have an emotional attachment to that credit. If you owned Ford, GM and Chrysler, and they represent less than 1% of your fund, you have it because you want a diversified portfolio. Your emotional attachment is dramatically less. Number two; we learned that you buy liquid paper. Back in 1994, we had 50 positions with an average size of 1% to 3%. We had illiquid positions. In other words, I was buying the yield, not necessarily buying liquidity. Number three, now we give up very little in losing positions. Q: Why have you shifted to a more diversified portfolio of credit instruments? A: Because it plays into our sell discipline. Everybody has the same four bullet points for their sell discipline. The problem is if you don't own liquidity and you don't own manageable position sizes, you can't sell. I don't care if you have a 500-page document that describes the stated sell discipline. Unless you can actually be tactical and get out of positions, you have no sell discipline. Period. We have a proven sell discipline where we monitor our assets, weekly, bi-weekly, monthly. If my credit team cannot explain to me negative price movement without any fundamental justification, that's a surprise to my shareholders and we no longer own that credit. Also, even the smartest guys I've seen out there have problems selling things. Anybody can buy. It's very difficult to sell. Q: I noticed from the mix of holdings in the portfolio, that the fund has exposure to practically everything in fixed income. A: That's the key defining fact. We're value investors in fixed income. That's the bottom line. We invest in anything that gives you a spread to Treasuries. We use all 12 sectors of the market. Q: An examination of the marketing literature indicates you have an international team of research analysts. A: We have a team of 12 sector specialists that have been together for 14 years. All we do is meet everyday and discuss valuations in those sectors. Behind those 12 sector managers, we have anywhere from two to six research people that provide depth and coverage. What we're seeing is a lot of smart bond guys listen to us and say, you know what, there is no way we can replicate what you do. There is no way they can replicate 33 people that manage 212 issues in the front part of the yield curve and generate the quality of returns and yield that we can. Q: Volatility is often a two-edged sword. A: We've been able to achieve the second lowest standard deviation out of 250 funds for a significant time period by being in all sectors, participating in low investment grade, foreign markets, and buying high quality non-dollar positions when we think it makes sense. And, by being tactical with liquid positions that really translate into long-term, solid performance. Q: You do have an eye quality. Double B rated bonds have outperformed single-B rated bonds over longer time periods with less volatility. A: Why not buy quality? As you know, 25 days represent 90% of the upside in the equity market. Certainly the smartest guys in the world haven't been able to identify those days until after it happened. Why should I try to buy single Bs and triple Cs to add massive risk to the standard deviation or to get a consistent high average monthly return over long periods of time? I buy quality. I don’t need the volatility. Q: Your multi-sector style says as a defining characteristic that you overweight undervalued sectors. What do you mean by this? A: There are competing sectors, with investment grade sectors competing against each other for allocation. Competing sectors are, for example, instead of owning government treasuries, we would own taxable munis and possibly even agencies. Instead of owning investment grade corporates, a competing sector would be Yankee investment grade, a foreign component that is dollar denominated. Munis could also be a competitive alternative to treasuries. There are a lot of things that compete as alternatives. It's our job to meet with our sector people and ask them to come up with fundamental and technical evaluations and for us to come to a consensus agreement on a model portfolio. Q: Isn't this market timing? A: Technical considerations to us involve what is driving the market. And, if it's not fundamental, can you still play it? For example, I might know that there is a large order in the market for Brazil exposure of multiple billions. Those are some of the secrets of the trade as to how you get your information when you get to 10-plus years experience. We can do that from a technical perspective. From a value perspective, we can put money into something we feel has good fundamental value. Q: Why do you say you have a duration neutral approach incorporated into the fund? A: This is one of the cornerstones of our process. We don't guess interest rates. At the portfolio level, we are neutral to that of our benchmark and peer group. In other words, I'm not going to give you 40 reasons why rates are going up and lo and behold, I'm wrong because there was one major event that caused rates to go the opposite way. As you know, Economics 101 would say that simple supply and demand imbalances move markets, However, it's more what expectations are than actual numbers that come out that move markets. I don’t think you can guess rates at the portfolio level. You leave that to the economists with their staffs of 40 people down on Wall Street to be wrong 14 out of 16 times on where rates are going. You let them guess with their team of professionals and then revise their outlook. We add value by picking sectors, by making issue selection bets in a small, diversified fashion and ultimately adding less volatility with more certainty to a portfolio's total return. Q: There are so many attractive areas worldwide in fixed income it makes all the eggs in one basket approach become less attractive in the current rate environment. Can it stay this way? A: It's sort of uncanny, but our product works best in a stable rate environment. It works in a gradual rising environment where spreads tighten quicker than rates tick up. In a downward rate environment, because it's a bond product, you also do well. Obviously if spreads blow out due to some extreme event, a terrorist event we wouldn't ever want to see, then we would slightly under perform. Q: Do you believe the fund is well positioned despite talk of an inevitable rise in interest rates? A: Again, if you're convinced rates are going up and you tell your bond fund manager to shorten his duration tremendously and lo and behold we have a terrorist event, which causes a massive flight to quality and rates drop precipitously, guess what? You just blew up your fund because you guessed rates wrong. You didn't make your small, consistent bets into issues and sectors. That's not our philosophy. It's hard to do. One of the best bond fund managers in 1987 was a guy that managed a 30-year Treasury fund of long duration. The market blew up; he returned 30%. He was on the cover of Barron's. The next two years, he got crushed, because rates went against him.