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much exposure to a particular credit or sector as either would have liked. And straying from that sweet spot in search of other opportunities wasn’t worthwhile with such a large asset base. Their records at PIMCO High Yield argue that they were successful managers, but Kennedy and Hudoff both say that it became more difficult to add value with their efforts, particularly as PIMCO began to put the same macro themes across all of its portfolios regardless of mandate. An evolution of the firm’s culture also brought more intensity to the job than either of them wanted, and by the time Hudoff left, PIMCO had become the full-blown pressure cooker that it is today.
13000

peg roughly 55% of the high-yield market as comprising bond issues with less than $500 million in outstanding issuance. And this fund likely will not be as heavily dominated by BB rated debt (the highest tier below so-called investment-grade debt) as was the pair’s PIMCO charge. It will have more assets in the B (and perhaps CCC) rating strata that make up the bulk of the high-yield universe.
There Is Work to Do

Ray Kennedy

Mark Hudoff

A Fresh Start
12000 After some time off, Kennedy started at Hotchkis and Wiley in late 2008. Hudoff 11000 followed in mid-2009, just a few months after Kennedy launched Hotchkis & Wiley High Yield HWHAX. Hotchkis is 50 miles away10000 from PIMCO in Los Angeles, but it might as well be in another solar system. Kennedy and Hudoff are two of 62 employees, more than half of whom together own a majority of the firm’s equity. And although Kennedy and Hudoff are running only a tiny slice of the firm’s assets, their presence is a big deal, not unlike a sports team that signs two established all-stars.

Kennedy and Hudoff do have challenges. They have two dedicated analysts and may hire a product specialist and trader. But for now, the goal is to leverage the breadth and skill of Hotchkis and Wiley’s 22 equity analysts to round out coverage of their portfolio. That group comes with its own pedigree. Vanguard’s Portfolio Review Group uses Hotchkis and Wiley to manage a $2 billion slice of Vanguard Windsor II VWNFX. Still, bond and stock managers look for very different things in companies. Kennedy found it necessary to give the analysts tutorials on subjects like evaluating bond covenants and capital structures. And Hotchkis has stipulated that it wants new analysts—who are typically hired out of business school—to start off focusing on equities before any become dedicated high-yield specialists. That arrangement may work, but its success is by no means assured. Don’t tell that to Kennedy and Hudoff. They’re energized by the challenge. Kennedy taught credit analysts in a prior life at Prudential Insurance, and he talks about working with Hotchkis’ analysts with the words and passion of a natural educator. It also won’t hurt that Hotckis is well known for managing small-cap value stocks—a universe that is home to much high-yield bond issuance. Roughly 75% of the credits Kennedy and Hudoff held early in 2010 overlapped with stocks that Hotchkis analysts were already covering. Ultimately, however, the time and attention that Kennedy and Hudoff have to devote to this

Hotchkis & Wiley High Yield HWHAX
$13K

BarCap Aggregate Bond

June 09

Jan 10

Category High-Yield Bond Morningstar Rating — Minimum Investment $2,500 Data through April 30, 2010.

Expense Ratio (%) 0.95 6-Mo Anl Total Rtn (%) 12.29 6-Mo Anl TR % Rank Cat 18

Kennedy and Hudoff talk about going to Hotchkis and Wiley as a dramatic, welcome return to their credit-analyst roots. Kennedy, in particular, talks about burying his head in company research as if it’s a calling from which he inadvertently strayed. Starting fresh, with a small asset base, will afford some strategic freedom, as well. Hudoff notes that he and Kennedy prefer the undervalued bonds of hard asset borrowers over the leveraged-buyout debt that dominates much of the high-yield market, and the two believe that working with Hotchkis’ large equity staff will help those efforts. As a result, they expect the fund to have broader credit exposure, inclusive of smaller firms with public equity, than PIMCO High Yield has offered. That’s going to mean a much wider variety of names, given that they

still-modest portfolio suggest that there is little risk in the need to calibrate the firm’s equity analysts to their bond research duties. Meanwhile, it’s difficult to come away Jun-09 Jan-10 anything other than encouraged after seeing two proven managers show Mar-10Apr-10May-10 Jul-09Aug-09 Sep-09Oct-09Nov-09 Dec-09 Feb-10so much enthusiasm and passion for their work. It’s rare in the high-yield universe to have two such investors, together, starting fresh with a small pool of money and so much flexibility. There’s never any guarantee that great managers will produce great results, but they almost always do in the fullness of time. K
Eric Jacobson is director of fixed-income research at Morningstar.

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Morningstar Advisor - June/July 2010

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