About a year ago we were looking at the nutritional market, which had been very weak, and particularly at General Nutrition. Their problem was partially related to the industry and partially to the company itself. The industry issue was related to the Atkins craze, a very profitable product that had become a large part of their revenues, about 30%. Unfortunately, when the Atkins craze died out, they were stuck with the inventory.

The company-specific issues had to do with supplier relations and ontime payments. They also had problems with their franchisees in getting them in line with the company’s operations. General Nutrition not only manufactures nutritional supplements but also has about 5,000 retail stores of which less than half are franchises. The company-owned units were always doing better than the franchisee operations but the franchisees always thought they knew better.

When talking with management, we discovered that they had hired two new executives especially to take care of the supplier and the franchisee issues and were implementing new incentives and measures. We also discovered that the company had pretty much liquidated the Atkins inventory. Going forward, we expected them to get back to normalized sales. So we estimated that the bonds were trading very cheaply and we took our position. The results in the next two quarters were very positive and continue to this day. Now it’s a question of when we decide to exit at this point.

Q:  In terms of portfolio construction, what benchmarks do you follow?

A: I don’t manage to a benchmark and I pay more attention to what the economy is doing or what interest rates are doing because that affects my portfolio much more than a benchmark. We keep the portfolio relatively concentrated at 35 to 50 names because over 50 bonds are difficult to know well individually. We’ve been emphasizing short-dated paper over the last year and, currently, effective duration is between 1.5 and 2 years. Right now about 50% of the portfolio is in short-dated bonds, 20% is in high-yield special situations, and the balance is split in the convertible area between busted convertibles, equity sensitive convertibles, and preferred convertibles.

Q:  What kind of risks do you perceive and how do you measure and control them, especially in the current phase of the cycle?

A: The major risk in any credit cycle is the default risk. We control that by focusing on cash flow and by doing extensive due diligence. For example, at the end of 2002, the rates were coming down and there was huge default risk in the telecom area. But due to our focus on cash flow, we did not have any telecom exposure because there was no free cash flow in that industry. We didn’t want to be in long-dated investment grade because we felt that the interest rate cycle was near an end.

Also, most of the companies that we’re buying have improving fundamentals. We tend to buy things when they’re down a bit and with improving fundamentals they hold up better in a down market. Even when they trade down, they usually don’t get hit quite as hard as the weaker credits.

And we’re not just looking at yields and leverage but also at operations and future potential. Many bond investors aren’t looking at the company’s prospects as much as they’re looking at where they are at that point in time. We do things a little bit differently and I think that helps us. We analyze bonds much like equity analysts analyze companies with the added layer of fixed income and credit metrics. As a firm, we analyze the companies and then decide what the best part of the capital structure is to invest in.