New Century Financial Group is structured more as a traditional investment manager than a hedge fund, but we found their approach to investing to be interesting enough and different enough that we wanted to interview the investment manager, Herb Friedman.

HedgeCo: Herb, thank you for taking the time to speak with us today.

Herb Friedman: You’re welcome and thank you for taking the time to do this interview.

HC: If you would, please tell us about your investment philosophy.

HF: We are different from both the traditional money manager and from hedge funds. We only invest in high-yield corporate bonds or high-yield municipal bonds. We focus on good returns with low risk and we have found that we can do that more times than not by using high-yield bonds.

HC: That is very different from traditional money managers and it is different from any hedge fund that I am aware of as well. Do you invest directly in the bonds or are you using ETFs as a proxy?

HF: Actually we use mutual funds. Our research has shown that with the model I developed, funds produce better risk adjusted returns than ETFs. I believe this is a result of the fact that funds have much lower volatility than similar ETFs.

HC: How many different funds do you keep track of and use in building your portfolios?

HF: We track between 15 and 20 in each of the categories (high yield and municipal high yield).  My trading signal tells me whether I want to be long or out on either the high yield or muni high yield bond funds.

HCV: Don’t these two segments correlate with their up and down movements?

HF:  Not at all. In fact, there is very little correlation (0.4) between the two markets.  In addition, there is very little correlation to the stock market. There are times when both corporate bonds and munis may be trending in the same direction, but that is only about 14% of the time. If both are trending up, we have a 50/50 mix. If both are trending down, we are 100% in money market. In years like 20o8, money markets can be a great place to sit and wait. In 2015 and the beginning of 2016, I was almost exclusively in municipal high yield bonds, and they have been one of the most profitable sectors in the market,

HC: Do you base your decisions on fundamentals or technical analysis? I know you mentioned your indicator determines where you are invested.

HF: I am a trend follower and that is what the indicator is based on. So it is 100% technical analysis that determines which asset class I will hold, but the fundamental analysis comes in with the fund selection.

HC: How does that work?

HF: Although I have really liked municipal bonds, Puerto Rico is a very risky area within municipals. Therefore, I have only been using municipal bond funds with no exposure to Puerto Rico. That is a fundamental decision.

HC: That makes sense, you tie the technical analysis in with the fundamental analysis in that manner. What would you say are the strengths of your strategy?

HF: What we are really trying to do is protect the downside as much as anything. We feel if we can provide solid returns on a consistent basis without suffering the big declines like the stock market sees from time to time, we can better serve our clients. That being said, our strengths are lower risk and returns that are not correlated to the equities market. In addition, primarily being invested in two separate asset classes which have very little correlation is a great advantage.

HC: What about weaknesses?

HF: Our biggest weakness is in that we have a limited capacity. Because of the markets we trade in, high-yield mutual funds and high-yield muni funds, we can’t take in billions of dollars to manage. We don’t want to move the prices on the funds. I think our maximum capacity is probably in the $100 million range and that is more than enough. In my experience, it is a big advantage in most trading to keep position size small.

HC: When you say “good returns”, what kind of returns are we talking about?

HF: Our audited, annualized five-year return is 7.92% and that is net of fees. Something that is even more impressive in my opinion is that the biggest drawdown is only 1.86%.

HC: That is impressive. Again Herb, I want to thank you for taking the time to speak with HedgeCo.net today and sharing your story with us.

HF: My pleasure. Thank you again.