Q:  Would you provide a brief overview of the fund? A : BlackRock High Yield Bond Fund was launched on November 19, 1998, and currently has approximately $8 billion in assets under management. Our mandate is to maximize returns on a risk adjusted basis in the high yield investment universe. Q:  What is your investment philosophy? A : We seek to make money in all markets. When risk is appropriately priced, we are prepared to add exposure. When risk is overpriced, we do not shy away from reducing our exposures. At the heart of our investment process is credit analysis. Having a global perspective in our investment approach, we match our macroeconomic view with individual securities selection with a thorough understanding of credit fundamentals. Q:  How does your philosophy translate into the fund’s investment strategy? A : Our global team includes over 40 professionals with expertise in security selection and macroeconomic analysis. This combined skill set helps us in analyzing companies across sectors and in diversifying across geographies. We start with a micro view as we analyze different companies within an industry. We have a core group of sector analysts who are constantly meeting with various management teams and reviewing earnings as they strive to understand what drives the cash flow of a business. As a further step, we take into account everything that we learn about supply chains and competition with regard to pricing and inventory levels in order to analyze and forecast cash flow. While challenging our macro view with the information flow from our micro view of companies, we recalibrate our assumptions to gain better insights into sectors and companies. Additionally, we follow fiscal policies globally and work to understand how monetary policy decisions made by central banks could impact capital flows through the financial system. With that understanding we challenge our assumptions that are baked into various business models. We are constantly looking to evaluate the tail risk as events from one region could spiral out of control and affect companies in other regions. As we hone in on the current cash flows and drivers of flows, we try to identify industry trends and various factors that are likely to impact cash flows going forward. We also pay close attention to the objectives of management teams and company owners along with the legal structure of each credit. What we focus on next is the individual security issued by the company and the terms of the covenants. It is important for us to scrutinize the language of the contract for the bond offering to better understand investor rights and the risks that we are exposed to. We get granular and evaluate not only the risks of prepayment but also the constraints the company may face in raising additional capital. Deep dive credit analysis is the core of what we do and also serves as our first step in understanding risk and portfolio composition. If we can understand what is going to drive the cash flow of a business, we can also figure out how it stacks up to its peers and make relative value decisions. Furthermore, our team of analysts and lawyers work together to dissect the legal risk and capital structure of a company and to understand the implications of jurisdiction the securities are issued from. Finally, we have traders and portfolio managers who are out in the market looking for the best relative value and trading liquidity. At any point in time we are looking to improve our risk-adjusted returns. Essentially, what we do is analyze the risk on a credit level before letting our three risk analysts decompose the fund from a top-down level. The risk analysts stress test the portfolio in different ways and analyze risk based on various macro environments. We look at correlations between different assets in a status quo environment in addition to stress tests aimed at understanding how the portfolio would act in different market environments. Based on these findings, we try to predict the pricing of risk relative to the overall macro environment along with looking at relative value to other asset classes – both fixed income and equity. Q:  How do you evaluate the merits and demerits of an idea? A : We formulate investment theses by challenging our assumptions to a point where we have conviction in the value and pricing of investing opportunities. If we identify a company or security that we want to create a position in, we add the name to the fund and analyze it both from a top-down and bottoms-up level to understand how it correlates to securities in other industries as well as analyze what is driving the company’s cash flows. Also, we will continue to monitor the company through meeting with management teams and talking to people in the industry. For example, at the beginning of 2009, we were buying investment grade BBB credits because our view was that Central Bank policy was going to facilitate borrowing by large companies when capital markets broke and the commercial paper market froze. However, as we progressed through the middle of the year, we saw certain areas of the economy recover from the severe downturn of the post-Lehman Brothers period as stimulus began to filter through the system. So, we started to look closely at the automobile market. Generally, an automobile is viewed as an asset that depreciates every single day. We started to break down the market by age, demographics and by geographic regions. In the fourth quarter of 2008, when the pricing of used cars had started to tick up, we started to evolve in our thinking. We worked more with auto and parts makers and also began to understand the auto replacement and repair cycles much better. When we scrutinized individual companies, we realized that those with global footprints were likely to turn around faster than others. In addition, companies with an aggressive cost focus were also well suited to ride out the downturn. We grew more comfortable as we began to receive monthly industry data and, at that point in time, we were ready to take positions in the automotive parts industry. Three years later, we still think that these companies are likely to continue to do well but the risk-adjusted return is not the same. At present, there are still auto parts makers that we like a lot, but based on our overall macroeconomic view of the industry, we have reduced our exposure. Q:  How do you build your portfolio? A : In general, we will have anywhere between 175 and 225 issuers in the fund without exceeding 3% in any individual position. Our benchmark is the Barclays Capital High Yield 2% Issuer Capped Index. Although we do not necessarily manage our portfolio based on the index, we are mindful of the benchmark as a whole because it represents our total investable universe. Because of our diversification and the names that we consider, we ultimately have a tracking error to the benchmark. The benchmark is not something that can necessarily be replicated. Q:  What are your sources of outperformance? A : Most of the return profile of our fund is driven by security selection. The high yield market is fairly fragmented and there are a lot of nuances that one has to take into account. For instance, if we look at the paper space, an investment grade company might be diversified across all grades of paper and various geographies. A smaller high yield paper company might be more focused on a specific grade of paper such as newsprint, while its investment grade counterpart has the benefit of diversity across various grades including container board. Both newsprint and container board fall within the paper sector, but they have two distinct demand cycles and drivers within the paper space. Newsprint is tied to local consumption of content that is being displaced by the Internet, whereas container board demand is tied to packaging of food sold at retailers across the nation. The supply and demand curves within those categories are very different in terms of pricing, capacity and the industrial capacity utilization. We attempt to identify and focus on companies whose fundamentals are improving by identifying the trends driving each business. Our risk-adjusted return profile is composed of individual securities we have in the fund, where we want to be on the curve, and what credit spread we are willing to accept. For the most part, the profile is driven by our investment thesis of the credit. Q:  How do you analyze risk and how do you mitigate it in the portfolio? A : We view and measure risk in many different ways and we constantly challenge our assumptions. For us, it is of primary importance not just to understand risk but also to factor in how it is priced. Our risk analysis is embedded into our research process and portfolio construction. The risk evaluation process starts with our analysis of a company as to what risks the cash flow streams may face. That analysis then drives our selection of company-specific securities. Some of the fundamental questions that we ask ourselves are: What if there is a new management team? What if the supply chain is under pressure? What are the potential impacts if the company or industry is tied to the broader economy and shifts in the macro environment or fiscal policy affect underlying demand trends? We also focus on understanding the levels of inventory in industries and whether those levels might force competitors to cut prices, which could affect cash flows for all industry participants. We also look at the current yields of securities that we are considering and determine their spreads to corresponding U.S. Treasury Notes, while understanding historical trends. Q:  What can we learn from the financial crisis of the past few years? A : The most important thing to learn from the last financial crisis is to challenge our assumptions and models. The majority of the world missed the widening of the subprime lending market to the mortgage market meltdown which spilled over into a banking crisis before pulling down the entire U.S. economy. Then, the fast evolving financial crisis led to a swift Central Bank response that pumped significant new liquidity into the mortgage market and into the broader economy. One thing that we learned from the subprime crisis is that you have to be ready to challenge your assumptions and be prepared to face different outcomes. We need to have an overall underlying view but versatility is important. Thus, if a macro event happens, a Central Bank shifts, or a government changes its fiscal course, we have to reassess and challenge our views and potentially change our positioning.