A fter cutting her teeth as a trader and analyst with Bernstein Macaulay's high yield bond and MBS desks in the 1980's Katonah Managing Principal and Portfolio Manager Joyce DeLucca, teamed up with Jim Ferguson and Andrew Godron to establish Octagon Credit Investors, an experienced leveraged-loan and high-yield bond investment manager, in the 1990's. Just as the company was about to be spun off in 1999, DeLucca met the Kohlberg family, which was looking to enter the CDO market - and the rest, as they say, is history.

At Katonah, DeLucca tends toward arbitrage CDO structures targeting leveraged loans and high-yield bonds with an overall credit quality of B1'/'Ba3' (Moody's Investors Service) or B+'/'BB-' (Standard & Poor's).

"This ratings category generally provides the best risk/reward combination for our portfolios, as well as relatively stable returns compared with lower-rated assets," said DeLucca. Indeed, DeLucca manages the CDOs as much like a total return fund as possible, constantly monitoring the portfolio's risk profile, taking profits and swapping out of assets when necessary.

In fact, the investment strategy for Katonah's CDO products matches the firm's overall investment philosophy: "Pro-active portfolio management will lead to superior investment selections and superior returns over time."

DeLucca positioned the portfolios defensively in mid-2001, to protect against the coming economic downturn. The firm also managed to avoid the telecom debacle. "By setting stringent investment parameters, we made better choices and were able to avoid most of the problems," she said.

And what of the currently booming high yield market - will this spark a switch back to the extensive use of high yield bonds as CDO collateral? DeLucca doesn't think so. "Although the (junk) market has been performing much better and the default rate is decreasing, I don't see the 100% high yield bond CDO coming back," DeLucca said.

It is relatively easy to find 20 to 30 high yield positions for a $400 million fund with a 15% high yield component. Finding enough solid positions for a fund that is 100% high yield, though, is another matter.

DeLucca also believes that CDO investors will be increasingly proactive in trying to structure protection into deals. Finally, she expects that the range of different CDO structures and features available to investors will continue to depend on the track record and strengths of the individual manager.

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