Your fund defies easy categorization, but most people probably consider it a high-yield bond fund. What sets you apart?

We’re really non-style box oriented and follow an absolute return strategy that’s grounded in common sense and balances avoiding excessive risk with the freedoms of a flexible mandate. That gives us the option to stock up on investment-grade debt when there’s an interest rate cycle and allows us to bulk up on high-yield debt and convertibles when there’s an economic cycle. Those two cycles move consecutively; they never outperform at the same time. Most funds are designed to sell [to investors], and it’s much easier to sell something that fits into a nice, neat style box. We don’t fit into a style box. That gives some investors pause, but people who get it really like it.

We also manage duration very aggressively, which sets us apart from other bond funds. For example, our current duration is probably under a year–very short term. When the market becomes volatile we like to dampen its affects on the portfolio; the easiest way to do that is to dial down the duration. I’m not the only fund manager that does that, but I probably take it to extremes that others don’t. If they’re managing their assets relative to a benchmark they might take it down a year or two versus the benchmark, but I’ll take it down where I feel the portfolio is correctly positioned. If that means buying six-month paper, so be it.

Because we’re fairly small and nimble, we can take advantage of a lot of unique one-off situations that much larger funds can’t, either because they can’t get enough to make a difference or they just have too many positions. We tend to run maybe 50 to 60 positions and do equity-like research on all of them, so we know all of our names pretty well. We look at them as businesses and look for free cash flow stories. But one difference between us and an equity team is that we also like to look for big cash balances, especially when we’re buying short-dated paper. When we’re entering a period of high volatility we look for big cash balances; that often means companies don’t have to come to the market to refinance.

We’re always trying to avoid the areas of greatest risk. When we first started in 2002, refinancing and rising interest rates accounted for a great deal of risk. What appealed to us most back then were convertibles that had issued either bonds and/or stock and kept the cash. Many of these names operated in the technology sector, but at the time there were a lot of great companies that had piles of cash and got the joke–that is, when things are trading at multiples of 100, sell stock. And when it trades at a dollar, buy back your bonds at 50 to 70 cents on the dollar. In many instances, we were competing with the companies themselves for their bonds.

This last go-around, short-duration paper became a sort of free option in the marketplace because a lot of hedge funds were getting liquidated and many mutual funds were selling positions to meet redemptions. And when these margin calls came in, the funds would often sell their short paper first; it’s usually the highest priced paper, so they didn’t mind knocking it down a few points. That really shot the yields up, resulting in inverted yield curves on many corporate bonds–mostly in the non-investment grade and crossover areas.

Forced selling by hedge funds worked to your advantage?

Without question. In some ways it was a hindrance because I started buying high-yield issues in October. I bought a month too early, so we got hit in the fourth quarter–that was my mistake. I thought we were in a reasonable place to start buying, but even though we only allocated maybe 15 percent of the portfolio to high-yield issues with longer durations, the move smarted a bit. It’s all bounced back since then but it wasn’t much fun at the time. You can never time these things; we did it very gradually. But at the other end of the spectrum we were buying one-year paper from companies like Home Depot (NYSE: HD) at 11 percent yields. It was crazy!

I guess you don’t see too many opportunities like this?

No, it’s a once in a cycle opportunity. We went into it with a decent cash position, so we were able to do some buying. I still wish I’d had more money under management at that point.

What purpose does your fund serve for investors?

I’ve been told by some very large investors that have put their own money into the fund as well as their clients’ assets that the appeal resides in our management style–we construct and adjust the portfolio in a way that limits potential blowups. We try to limit risk exposure and avoid the most dangerous areas of the market; our goal is to keep people rich while generating a reasonable return. We want our clients to be able to sleep at night.

Our biggest investors also appreciate that the fund doesn’t have a high correlation to the bond market because I manage the portfolio with an eye to absolute returns–I’m not dependent on a move in interest rates to make money. They also know that I do my homework before making a move. I do make a mistake every now and then, but for the most part we’re very careful and tend to focus on companies that have good cash positions.

Our flexible mandate is another advantage. Our experienced team seeks to take advantage of opportunities while structuring the portfolio to limit risk. That top-down asset allocation is crucial and enables us to adapt to difficult market conditions much better than other funds.

You’ve been buying issues that are lower down on the credit-quality ladder. Do you worry that such an approach might give investors pause?

Who are you going to believe, the guys with 64,000 AAA-ratings or me?

Ratings agencies have their criteria for what they consider an investment-grade company, and I have mine. They look over the long term when determining credit quality, which is a perfectly fine approach. But those criteria become less relevant when you’re investing in short-dated fixed-income securities. For example, we own convertibles in Novell (NSDQ: NVL), a company that does for big corporations what Red Hat (NYSE: RHT) does for open source software. Novell just mints money and generates huge free cash flow. Right now the company has more than $1 billion in cash on its balance sheet. And the firm’s only debt obligation is a $125 million convertible that they’ve been buying back. We bought it at a yield in excess of 10 percent to the put it has in July. Is it a problem that it’s unrated? The company has ten times the amount of cash to its debt and throws off tons of free cash flow–we’re not too worried.

Another example is one of the largest advertising agencies in the world. This company has experienced some issues in the past and made a few acquisitions, so people have had valid concerns. But a new management team is in place, and we think they have these issues well in  hand; the firm has learned its lesson and keeps some $2.2 billion in cash on the balanceheet–a big difference from a few years ago. The company has one maturity this year, which we own, worth $250 million. Management has repeatedly said that the firm will pay this obligation out of cash without incurring any problems. But because it’s an advertising agency and the economy is soft, we bought the bonds at a better than 13 percent yield even though it’s a B+ rated company.

Do I really care what the ratings agencies think about the company? Again, this advertising agency’s cash position is ten times its debt, and its balance sheet isn’t hemorrhaging cash.

I can go through my portfolio name by name; you’ll find that the rating agencies have their criteria, and we have ours. I’m primarily concerned with getting my bonds paid off. We’re not going to buy a company that’s bleeding a lot of cash. If a company’s breaking even or making money and boasts a strong cash cushion, that shows that management’s fairly conservative and understands that the debt out there needs to be paid off. The average weighted rating of my portfolio is BB+, just under investment grade; we’ve bought a fair amount of BBB paper over the last six months.

I’m mostly indifferent to ratings because I look at the company’s themselves, using equity-like analysis.

Where do you think the best opportunities will be over the next twelve months?

I’m rethinking that now. The high-yield market has had quite a run here lately; at first blush the high-yield segment of the bond market still appears to trade at a wide spread, but it’s actually quite bifurcated. Many of the higher quality companies that were yielding handsome returns have tightened dramatically, yielding maybe eight to 10 percent at most. Then you have some of the more depressed cyclical names that are trading at maybe 20 or 30 percent yields.

I think the opportunity’s probably going to be in identifying those companies among the depressed names that don’t deserve to be there.