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Making the Grade

Strong's Koch Sees High-Yield Bond Sector as Ripe for Niching

September 23, 1997|TOM PETRUNO

Jeffrey Koch has helped make the Milwaukee-based Strong Funds a player in the bond fund business.

Koch, now 33, joined Strong in 1989 right out of MBA school. He has been managing portfolios for the company since 1991 and since 1995 has headed Strong's high-yield bond sector, which now is a small but fast-growing segment of the company's $14-billion bond fund business.

As a bond manager, Strong has become best-known for its emphasis of shorter-term portfolios that attempt to deliver above-average yields without subjecting shareholders to significant share price volatility.

As the lead manager in the high-yield, or junk, bond business at Strong, Koch has been riding that sector's surging popularity with small investors in recent years.

Koch talked with Times markets columnist Tom Petruno about Strong's high-yield bond philosophy and the market in general.

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Times: How did you get into the high-yield bond business?

Koch: We started up the Strong High-Yield fund at the end of 1995. But we've always been involved with high-yield in our investment-grade portfolios. Three of those funds can go up to 25% in BB-rated securities, so we've always been involved in the highest-quality part of the high-yield market.

That's about half the high-yield market. People don't usually realize that, because if you look at the typical high-yield fund it's 80% B-rated bonds on average, 10% BB-rated bonds and 10% or 5% cash. But the high-yield market [overall] is 46% BB-rated issues, 47% Bs, and the rest is CCCs.

We looked at our product lineup, and we had domestic investment-grade bond funds, we had international bonds, and then we needed high-yield. I volunteered. I liked the market and saw it as a challenge and an interesting change from what I was doing.

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Times: Well, there obviously were a lot of high-yield funds out there before yours, but it looks like you may have already made up for lost time, given the huge inflows into high-yield funds in recent years.

Koch: That's right. The sector has been getting tremendous inflows. Our High-Yield fund started with $1 million in December 1995. It's over $500 million now.

High-yield is the only [bond sector] that's come close to competing with equity returns. Our High-Yield fund was up almost 27% in total return last year. This year it's up almost 12%.

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Times: And now you've rolled out a Short-Term High-Yield fund. Where did that idea come from?

Koch: Our view was that here you have this high-yield market, it's a big market, $360 billion in securities and growing pretty rapidly. You've got 204 high-yield mutual funds which are almost $80 billion in size. But they're all lumped together in the same category [by fund-rating services].

If you look at the investment-grade bond market, which is much more mature and well-developed, you've basically sliced and diced it as an industry to the point where you have ultra-short-term funds, short-term government funds, short-term corporate funds, intermediate-term funds . . . and so on.

Yet high-yield is just one wide-open universe. We have a lot of shareholders in our biggest funds, which are in the short end of the interest rate curve. Our Advantage Fund and our Short-Term Bond fund together are just over $3 billon in assets. So we have a lot of people in our shareholder base who are interested in a higher level of income than you can get in money market funds. Our thought was that they would be interested in a fund that would offer an even higher level of income, with low share price volatility.

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Times: When you say short-term high-yield bonds, how short-term are we talking?

Koch: We want to run the fund with a one- to three-year average maturity, with a volatility in share price that's probably going to be half the volatility of our High-Yield fund. And in terms of yield, the Short-Term High-Yield fund should provide another 100 basis points [1 percentage point] in yield . . . over our Short-Term bond fund, the investment-grade fund.

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Times: What is the yield on the Short-Term High-Yield fund now?

Koch: Right now it's 7.6%, but that's a little deceiving because it's a 30-day look back. We started the fund July 1. It's still a small fund, with $30 million in assets, $14 million of which came in from the Strong Advisor program [an asset-allocation service]. It's taken us a little time to get that money invested, so we've had quite a bit of cash. I think when all is said and done in the next 20 days the yield will probably settle out around 7.8% or 7.9%. Our Short-Term Bond fund, which owns investment-grade bonds maturing in one to three years, yields about 6.75%.

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Times: And what about the main High-Yield fund?

Koch: That yields about 8.8% now.

Times: Besides the obvious difference of focusing on shorter-term bonds in the Short-Term High-Yield fund, how else does it differ from your main High-Yield fund?

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