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The Top Recovery Play? Corporate Bonds

Expecting the economy to recover over the next two years, Thomas Marthaler, manager of ABN AMRO Chicago Capital Bond Fund (CHTBX), favors corporate bonds poised to gain as interest rates rise. Marthaler's fund is comfortably ahead of most intermediate-term, medium-quality bond funds for this year and in past years. For 2001 through October, Capital Bond rose 9.4%, versus 8.1% for its peers, and for the five years through October, the fund returned an annualized 7.5%, versus 5.6% for its peers.

This year, the fund's gains have come from convertible bonds and an underweighting in mortgage bonds, according to Marthaler. Over the long-term, Marthaler said his asset class -- intermediate-term investment-grade bonds -- shows higher results than either short-duration or long-duration bonds.

Bill Gerdes of Standard & Poor's FundAdvisor recently spoke with Marthale about about the fund's investing strategy. Edited excerpts of their conversation follow:

Q: What's the fund's asset allocation?

A: Currently, we're 40% in corporate bonds, 32% in government securities, 10% in high-yield bonds, and 2% in asset backed securities. Our long-term view is that corporates will do better as the economy recovers and interest rates move higher.

Q: What is the fund's


A: It's about 4.5 years, since we've been slightly defensive this year. Generally, we're within 98% of the duration of the Lehman Aggregate Bond Index.

Q: What are the largest sectors for your high-yield holdings?

A: Most of our high yields are in industrial categories, but we're also overweighted in health care, which, year-to-date, is probably the fund's best performing area. In addition, we have exposure to telecoms, though we'll probably sell a Global Crossing holding by the end of the year because it hasn't done well. To reduce risk, our maximum weighting for a high-yield holding is 1.5%.

Q: How do you monitor risk?

A: We use stress testing, which looks at a bond's expected returns compared with its sector and risk-free securities. Since we focus on the long-term, we don't actively increase or shorten our duration based on day-to-day economic events.

We also control risk by diversifying, with no bond making up more than 3% of the portfolio.

Q: How do you select securities?

A: We calculate the cost of adding a bond to the portfolio, and then projecting its returns, typically for a two-year time horizon. We consider a bond's future returns under a variety of scenarios and will only buy those with expected returns matching or exceeding the Lehman Aggregate Index for at least 75% of the time.

Q: What has helped the fund's returns this year?

A: Some convertible bonds, such as Waste Management, have done well, as have low-duration securities of under five years. Our underweighting in mortgages has also had a positive impact.

Q: What's the benefit of investing in intermediate-term investment-grade bonds?

A: They have the highest risk-adjusted returns relative to short-duration and long-duration securities.

Q: How has ABN AMRO's acquisition of Alleghany Funds, Chicago Capital Bond's previous owner, affected the fund?

A: ABN AMRO Bond Fund merged into our fund in September, but we had transitioned our holdings before then so the merger had little impact on our shareholders. From Standard & Poor's FundAdvisor

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