Safety in Steering Clear of the Bankrupt

Firm Finds Value In Market for Leveraged Loans

Mark Okada, who manages two U.S. mutual funds that invest in bank loans to struggling companies, is beating his competitors by dodging bankruptcies.

Okada's $1.4 billion Highland Floating Rate Advantage Fund returned 10.3 percent in the past year, the most among 19 similar funds tracked by Bloomberg News, by avoiding borrowers such as Atkins Nutritionals Inc., which defaulted in February 2005.

"Your job as a manager is to create value for your investors by avoiding things before they go down," said Okada, 44, who co-founded Highland Capital Management L.P. in 1990.

Okada focuses on the $1.2 trillion leveraged-loan market for companies at risk of failing to pay their debts on time. Highland Floating Rate Advantage's top holdings in April included loans to U.S. lumber company Georgia-Pacific Corp.; Blockbuster Inc., the world's biggest video-rental chain; and Charter Communications Inc., the fourth-largest U.S. cable-TV provider.

Leveraged loans last year unseated high-risk, high-yield "junk" bonds as the most popular way for companies with credit ratings below investment grade to borrow. Highland Capital of Dallas is among the biggest investors in the market, with $25 billion of assets, including $19 billion in loans.

Investors prefer loans to bonds because loan prices are more stable, Okada said. Unlike the typical junk bond, loans are backed by a company's assets, making repayment a safer bet in case of a bankruptcy.

Loans also offer protection against rising interest rates because their yields are tied to Libor, or the London interbank offered rate. The average loan fund rose 4.6 percent last year, beating the 2.5 percent return of the average junk bond fund in a period when the Federal Reserve increased its benchmark overnight lending rate eight times to 4.25 percent, according to data compiled by Morningstar Inc., a Chicago-based research firm.

"It's too simplistic to say interest rates are what drive the loan asset class," said Okada, who has degrees in economics and psychology from the University of California at Los Angeles. "This is a credit-based product."

Highland Capital, named after the Dallas suburb where Okada and co-founder James Dondero live, is among the biggest managers of collateralized loan obligations. It employs about 75 money managers and analysts to monitor 1,200 borrowers. By contrast, Boston-based Eaton Vance Corp., with $17.8 billion in bank loans under management, has 19 portfolio managers, analysts and consultants, company spokesman Jim Naughton said.

The $4.7 billion Eaton Vance Floating Rate Fund advanced 4.4 percent in the past year. The Highland Floating Rate Fund, which unlike the Advantage fund doesn't use borrowed money to try to enhance returns, climbed 7.7 percent.

The funds' benchmark, the Credit Suisse Leveraged Loan Index, rose 6.6 percent in the 12 months through April.

Unlike stocks and bonds, loans purchased at face value have limited potential to rise in price as a company's prospects improve because the company can refinance at a lower interest rate.

Highland Capital bought bank loans that were made in December 2003 to Atkins Nutritionals, the Melville, N.Y., promoter of the low-carbohydrate Atkins diet.

Okada sold the loans at 100.5 cents on the dollar because of concern about foodmakers including Unilever NV and Hain Celestial Group Inc., which introduced competing low-carbohydrate products. Atkins went into bankruptcy last July, owing about $325 million. Creditors now stand to recover about 15 cents on the dollar.

Highland Capital boosted returns in the past year by buying bank debt of companies in troubled industries such as airlines and automobiles, Okada said. Such debt can be backed by relatively liquid assets such as spare parts or air routes, and the companies pay a relatively high interest rate because most investors are reluctant to lend to them.

Highland Capital owned the bank debt of Delphi Corp. of Troy, Mich., and Northwest Airlines Corp. of Eagan, Minn., which gained in value in bankruptcy because of the collateral backing it.

"While we can never anticipate future performance, we can get paid for the value of providing liquidity in an industry where no one wants to be a lender," Okada said.