Understanding the intricacies of the companies in which they invest and closely studying their managements is the reason that the two Catalyst Credit Opportunity Funds have had such a good return this year, according to portfolio manager Brett Levie.

Both hedge funds are distressed-debt oriented, but have mandates that allow them to invest anywhere in the corporate capital structure, he said.

The two funds – the $53.8 million Catalyst Credit Opportunity Offshore fund and the $17.4 million Catalyst Credit Opportunity Fund – are up 14.04% and 15.61% respectively, according to a letter to investors.

By comparison, the Credit Suisse First Boston high-yield index is up 7.08% this year, and the 92-fund Hedgefund.net index is up 9.90%. Last year, the Hedgefund.net index returned 31.33%.

Distressed debt is debt or loans issued by corporations that have stopped paying either principle or interest on the bonds. Hedge funds often buy these bonds prior to the declaration of bankruptcy and after several months, are issued stock or new debt in a company that has a cleaner balance sheet and new management.

In describing the distressed market, Mr. Levie said: “We are in the late stages of one of the great markets for distressed and bankruptcy ever.”

He said that the bull market for distressed bonds was fueled by both the record issuance levels of junk bonds in the late 90s, as well as the corporate bond debacle of 2002, when spreads expanded to some of the widest levels in history. “Hedge funds, with a lot of cash coming in, were presented with dozens of companies that had decent balance sheets, which rallied nicely as rates dropped and the economy recovered, ” he said.

Mr. Levie said investors still have tremendous appetite for risk and a lot of cash to put to work.” We are seeing lots of triple-C paper hit the market and get snapped up quickly.” Triple-C is the lowest available debt rating and statistically tends to fall into bankruptcy more rapidly than any other credit sector. One example of this, he said, was Interstate Bakeries – the maker of Twinkies and Wonder Bread- which declared bankruptcy 42 days after issuing a convertible bond. “It’s pretty much a record for a company getting into trouble,” he said.

Mr. Levie offered Interstate as an example of a company that a research-intensive hedge fund like Catalyst investigates. “They have well-known brands, but antiquated bakeries and bad delivery routes, so we sit down and think about whether these are surmountable problems,” he said.