Ray Kennedy and Mark Hudoff, self-described "credit geeks," are back doing what they enjoy most: finding cheap credit bonds and plowing through the details as portfolio managers of Hotchkis and Wiley Capital Management's new high-yield fixed-income fund.

The two men honed their credit skills for ten years each at Pimco, where they managed the firm's high-yield assets. Kennedy retired from Pimco in 2007 and spent the next year and a half working on charitable endeavors. In October 2008, longtime friends who are principals at Hotchkis and Wiley in Los Angeles asked him to start up a high-yield business at their firm. He came on board the next month, and began trading in February 2009. In June, the SEC-registered Hotchkis and Wiley High Yield Fund opened and in July Hudoff joined him there.

Pimco's high-yield business had some $35 billion under management when Kennedy left, and was larger still when Hudoff departed two years later. "Both of us loved Pimco," says Kennedy, "but starting with a small business, watching it grow and then growing to a big business, things change. You have to change your style, your approach to the market. When we started in high yield, an $800 million business, we were able to buy unique off-the-run issues that were very credit intensive."

Hudoff recalls "the halcyon days at Pimco, when we had a relatively small footing [and] very close relation to the clients and products. But when you get to the size we were at, we were spending our days managing cash flows, managing reports to explain everything that was going on, which is responsible portfolio management in a big organization. But it was less of a credit job and much more of managing the landscape."

At Hotchkis and Wiley, he says, "we're looking for the best risk-reward ideas that we can find in the marketplace. Rather than being driven from the top down from a macro perspective, we're much more focused on the bottom-up stock picking of individual securities." Kennedy adds, "That's what attracts both of us because we're both credit geeks and grew up looking at companies, and that's fundamental to this business."

Another attraction of the smaller firm is that it's run by its owners, he says. "Everyone is working toward the greater good of everyone's equity ownership," says Hudoff. The company is small, with a total of 63 employees. "Ray and I love building businesses, but with a real craftsmanship approach toward both the product and the client," he says.
They also like the fact that Hotchkis and Wiley isn't bashful about closing funds to new investments if size starts to drag on returns.
"Ray and I have talked about this a lot," he says. "When a fund gets to be large enough so that becomes an issue, we won't have any kind of problem, and no one at Hotchkis and Wiley would have a problem with us closing it."

The High-Yield Strategy
By keeping the sizes of their funds under control, Hudoff and Kennedy say they have greater freedom to delve into the smaller segment of the market-deals that are less than $500 million in total debt at a company.

"One of the things you'll see in our strategy now is to take advantage of some smaller cap names-very credit-centric stories," Hudoff says. "We have 22 analysts covering the U.S. market. ... That plays very strongly to a small-cap shop having an edge over a large-cap firm."

The high-yield market historically has comprised fallen angels, core names and small caps, according to Kennedy. From 2004 to 2007, the differences between those segments were relatively small, owing to low volatility in the market. But as volatility picked up in 2008 and 2009, the separation between them increased significantly, creating opportunity, he says. Hotchkis and Wiley has a value orientation on the equity side, so its analysts know the fallen angels very well. Likewise, the analysts know small-cap names because the firm offers a small-cap product. "That's where our alpha is going to come from our strategy-from those wings," he says.

The Hotchkis and Wiley high-yield investment philosophy is defensive, the managers say. "You start with the premise that you're looking for an improving credit and want to avoid the losers," says Kennedy. "Along with that, we're looking for improving companies-companies with significant asset coverage and companies that have a reason to exist."