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Dodging Bullets in the Bond Market

Tom Carney, manager of Weitz Short-Intermediate Income, reveals how he topped the short-term bond category.

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Michael Breen: Greetings, this is Mike Breen, coming to you from the 2009 Morningstar Investment Conference. We're fortunate to have Tom Carney of the Weitz Funds here. He runs the Short-Intermediate Bond Fund (WEFIX) for them, one of the top-performing bond funds in that category here at Morningstar. Welcome, Tom.

Thomas Carney: Hello. How are you?

Breen: Interesting market the last couple years. I'm an equity guy, but naturally pay attention to the bond markets. We saw some things we thought we'd never see, sort of implosion in short-term bond funds, things that looked like they were quality turned out not to be. You guys pretty much dodged all of that. What were you doing different than others that you kind of dodged all those bullets?

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Carney: I don't typically pay that close attention to what others are doing, but what we did do--which may have been different--is up until early 2008, we'd noticed the spreads on the investments that we typically would make in the fund increasingly getting narrower and narrower. And so for us, we ultimately start by understanding the investment we're making. But wanting to be compensated for that incremental risk as being a lender, and ultimately knowing that incremental return is what will compensate us over time. The byproduct of that is to have a very, very small exposure to credit into the first half of 2008, an all-time low for our fund in terms of having corporate exposure.

And so that potentially helped us. It certainly would have helped us dodge a lot of the re-pricing that took place very rapidly as we closed out 2008.

Breen: You actually own a little bit more now than average for your category, in terms of corporates. Did that sort of creep back up? Or were there one-time opportunities in late '08 when spreads got really strange?

Carney: Absolutely. I think that the spread environment that occurred into late 2008 and still exists today brought us back to levels that we felt we were being adequately compensated for taking on that incremental credit risk. And so as of the first quarter, our credit or corporate exposure is in the mid-30% from meaningfully less than 10% less than a year ago. And having done much of the work as a firm, the credit culture that we have and the work that we do in the equity portfolios really provide us ample opportunities to look higher up the capital structure in companies we already knew and whose bonds seemed increasingly mispriced.

Breen: And since you have a decent amount of corporate relative to you peers - issuance had kind of dried up for quite a while there, and there's no liquidity in the market. How is that looking now? Better?

Carney: It really picked up. We were not that involved in new issue market. But we certainly have seen the willingness of investors to take on new risk certainly come back in a very large way now. Credit spreads had widened to arguably Depression-era levels in December, and have since really come in quite a bit. And corporations are certainly taking advantage of that by the issuance that has occurred in the last few months. That gives us an opportunity to certainly possibly take advantage of those. But I think spreads over all have come in quite a bit. The opportunities still seem to be, less than they were at the end of '08. But the investment community had certainly become less worried about the ability of companies one, to finance themselves, and just the level of anxiety in the market certainly seems to be lower than the March 8th or 9th low.

Breen: So things have stabilized and there's still good opportunities for you as a credit researcher to add value from the bottom up.

Carney: Yes.

Breen: OK, great. Thank you very much for your time. Appreciate it.

Carney: Thank you very much, Mike.

Breen: Thank you.

Michael Breen does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.