8/11/2019 Undiscovered Managers

1/2Morningstar Advisor June/July 201052

Undiscovered Managers

Ray Kennedy and Mark Hudoff are a couple of

happy guys. Its certainly not because theyre

sitting atop an empire. Theyre running a little

more than $100 million at a small firm that

boasts a modest $15.7 billion under manage-

ment and has the distinction of havingundergone two changes of ownership in the

past 10 years.

Their lives appear to be more fulfilling than they

had been for a while, though. Things went well

enough when they started at PIMCO. They

were hired and mentored by Ben Trosky to hunt

for high-yield bond issuers with hard assets,

cash flows, and compelling credit profiles.

Kennedy and Hudoff worked together at PIMCO

for about 10 years, five as analysts under

Trosky, who built a great record and reputation

running PIMCO High Yield PHYDX. Kennedyeventually joined Trosky as a comanager and

succeeded him when Trosky retired at the end

of 2002. Kennedy then turned the reins over to

Hudoff in 2007. Hudoff left PIMCO last year.

Neither Kennedy nor Hudoff have anything bad

to say about PIMCO, and they remain big fans

of their colleagues who remain at the firm. A

the pair sound almost wistful when describ

their analyst days under Trosky. Yet its clea

that a toll was taken on Kennedy by the tim

he left in 2007 and that the place no longer

suited Hudoff when he departed in 2009. Eareigned atop an enormous pool of high-yield

bond assets during his managerial tenure, a

the challenges were huge. The funds relati

conservative strategy meant that they favor

better-capitalized issuers and large liquid

bonds. But even so, the funds size meant th

there were times when it was difficult to ge

Escape From the PackBy Eric Jacobson

After grinding away at the mother of all bond firms, two high-yieldbond managers find solace in running a tiny fund at a tiny shop.

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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

wasnt worthwhile with such a large asset

base. Their records at PIMCO High Yield argue

that they were successful managers, butKennedy 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

firms 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.

A Fresh Start

After some time off, Kennedy started atHotchkis and Wiley in late 2008. Hudoff

followed in mid-2009, just a few months after

Kennedy launched Hotchkis & Wiley High Yield

HWHAX. Hotchkis is 50 miles away 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 firms

equity. And although Kennedy and Hudoff are

running only a tiny slice of the firms assets,

their presence is a big deal, not unlike a sports

team that signs two established all-stars.

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 its 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-yieldmarket, 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. Thats going to mean a

much wider variety of names, given that they

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 pairsPIMCO 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

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 Wileys 22 equity analysts to

round out coverage of their portfolio. That

group comes with its own pedigree. VanguardsPortfolio 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 analystswho are

typically hired out of business schoolto

start off focusing on equities before anybecome dedicated high-yield specialists. That

arrangement may work, but its success

is by no means assured.

Dont tell that to Kennedy and Hudoff. Theyre

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 wont hurt that

Hotckis is well known for managing small-cap

value stocksa universe that is home to muchhigh-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

still-modest portfolio suggest that there

is little risk in the need to calibrate the firm

equity analysts to their bond research

duties. Meanwhile, its difficult to come aw

anything other than encouraged after

seeing two proven managers show so much

enthusiasm and passion for their work.

Its rare in the high-yield universe to have

two such investors, together, starting fresh

with a small pool of money and so muchflexibility. Theres never any guarantee

that great managers will produce great resu

but they almost always do in the fullness

of time. K

Eric Jacobson is director of fixed-income research

at Morningstar.

Category Expense Ratio (%)

High-Yield Bond 0.95

Morningstar Rating 6-Mo Anl Total Rtn (%

12.29

Minimum Investment 6-Mo Anl TR % Rank

$2,500 18

Data through April 30, 2010.

Hotchkis & Wiley High Yield

HWHAX

Ray Kennedy

Mark Hudoff

l

$13K

11

June 09 Jan 10

BarCap Aggregate Bon

12