(FORTUNE Magazine) – Seven thousand, seven hundred and twelve feet above sea level, Robert Kessler is climbing a rock. Not just any rock, mind you. This is the Sphinx Rock Group, a vertiginous climbers' mecca located in the Rocky Mountains outside Denver. Kessler is clambering up 400 feet of sheer granite without pinions or ropes. His chalked fingers run over the smooth surface searching for grooves as his eyes survey the face. He moves silently, methodically. When he reaches a small plateau, Kessler turns to take in the view. With a lock of unruly brown hair drooping repeatedly into his eyes, he looks nearly half as old as his 61 years. He has been so focused that he has barely noticed the blood that's been streaming down his hands since he cut both of them on the rocks ten minutes ago.

Yes, Robert Kessler loves to take on mountains. And if that seems like an extreme pursuit for a middle-aged bond-fund manager, it's actually fitting in Kessler's case: He has made a career out of taking the most conservative form of investing--stodgy old U.S. government bonds--and giving it an extreme twist.

Before we tell you exactly how he does it, consider the results: Kessler Investment Advisors, which manages $1.2 billion in U.S. government bonds and cash, has generated a scintillating average annual return of 13.3% over the past 14 years, according to the firm's audited results. That compares with 9.4% for the average long-term government-bond fund during that period. Last year Kessler's clients netted a 24% return after fees, besting the average fund's 16.2%. (Alas, those juicy payouts are not for most of us: Kessler requires a minimum $1 million investment.)

Kessler has the nerdy passion of a classic fixed-income wonk ("Did you see the way the ten-year bond performed last week?" he asks excitedly), but it wasn't always heart-racing stuff. Not, that is, until an autumn day in 1989, when Kessler, sitting in his office in Denver, had a seemingly simple idea: Why not take a strategy that was used by institutional investors and apply it for individual investors?

Kessler was accustomed to tapping into a banking netherworld comprising repurchase agreements--the so-called repo market--for his corporate and institutional clients. It is a $3.7 trillion component of the money market system, where giant entities lend and borrow money in billion-dollar chunks for brief periods at ultra-low rates. Essentially, institutions put excess cash to work in such large amounts that even a few basis points on an overnight transaction can be profitable. Individual investors don't have the necessary sums to play.

But Kessler realized that if he packaged his clients' assets together, he could achieve the bulk--you typically need at least a $100 million ante--to make the repo market pay. That would enable clients to borrow money at interest rates far lower than they could obtain at any bank or brokerage--as little as 0.5% or less. That, in turn, opened up whole new possibilities. Clients could leverage their investments much as they would with margin loans, but at far lower rates than they could get from a bank. They could use that money to buy high-quality U.S. government bonds (using those same bonds as collateral) and get returns ordinarily available only from high-risk junk bonds.

There was, as it happens, one large obstacle: investment banks that cater to the same wealthy clientele that Kessler serves. Banks don't want those valuable clients packing their Louis Vuitton bags and leaving, or demanding lower rates on margin loans. As Kessler remembers it, "at least a half-dozen" elite Wall Street investment banks refused to clear his bond trades because they thought his strategies might lure away their high-net-worth clients. "We're not giving away the bank," exclaimed one. Others raised the fees they charged for executing the trades until it became so costly that Kessler was forced to take his business elsewhere. He persevered, though, and eventually found smaller brokerages to handle his bond trades.

The repo market actually has a familiar premise--buying in bulk gets discount prices--in this case, on the cost of money. Everybody from corporations to central banks does it. "It is the absolute lifeblood of any bank or brokerage firm, and the reason all other markets can operate," says Thomas Wipf, head of the repo desk at Morgan Stanley. A repo is basically a short-term agreement to loan cash or securities and then buy them back later, say overnight or in three months, at a set price.

The basic concept is fairly simple, but there are endless arcane permutations. That convoluted environment is one that Kessler thrives in. Walk the pebbled pathway of one of the large greenhouses on his 75-acre mountain ranch near Denver, and he will discuss bromeliads, caudiciforms, and Encyclia bractescens as though they were as common as daffodils. Kessler and his 44-year-old wife of eight years, Lisa, are exotic-flower enthusiasts, delighting in rare blooms from Brazil, Africa, and Southeast Asia. "I like pretty things," he says. And complex ones.

Kessler is a numbers geek who rejected the sexy world of stocks to make a career in the more sedate realm of fixed income. In the 1970s he cut his teeth alongside Arthur Levitt, the former SEC chairman, working in fixed income at Shearson Hayden Stone. His eyes dance as he recites the exact mathematical calculations--tied to interest rates and inflation--that define the risk and price movement of any Treasury bond. He speaks of a Treasury's promise of "the full faith and credit of the U.S. government" with the fondness of a person nostalgically recalling his first love.

Kessler has long been able to make money in unusual places. He proudly recounts how, in the late 1980s, he and a partner uncovered an obscure market in "fish bonds." The Commerce Department had launched a program that guaranteed 80% of the value of certain fishing vessels. Kessler jumped in.

His investment insights have made him a wealthy man--Kessler admits, with much prodding, to being a "triple digit" multimillionaire--but a somewhat reclusive one. He'd rather not talk about rubbing shoulders with the super rich. He has a house a few doors down from Bill Gates' place on the grounds of the Vintage Country Club in Indian Wells, Calif. "I don't really belong there," Kessler says of his membership in the club.

He prefers to refer to himself as a farmer (without adding "gentleman" in front of the noun), an excessively modest term given the precincts in which he lives. Still, he and Lisa will sometimes send guests into the garden to fetch their own lettuce. For a man who grew up on Shelter Island, a well-to-do enclave nestled between the North and South Forks of Long Island, Kessler treats his own success like an uncomfortable skin he has yet to grow accustomed to.

As much as Kessler seems to shy away from attention, he conveys the sense that he is a man who has made a great discovery that the world has yet to appreciate. "It's damn frustrating," Kessler says. "But, I guess, there will always be smarter ways of doings things that people just won't understand."

"Mur-phy!" Kessler calls out as we make our way through the paved walkways of his estate. A dusty brown horse gallops out of the woods to greet Kessler, who softly rubs Murphy's head. Strolling past brightly colored birdhouses, he shows off the golf house that sits on a hill above his private nine-hole course. He's happy these days. Among other reasons, bonds are suddenly cool among a certain segment of the ultra-rich. For years, bonds, particularly Treasuries, were synonymous with the geriatric crowd--those buyers more concerned with regularity than returns. But Kessler has found a growing client base (he has about 120 clients) among fortysomething former dot-com tycoons and IPO millionaires who cashed out before the bubble popped. These days, nothing turns them on more than cash.

And Kessler is the king of cash. Here's how he does it. First, remember that his is a bond strategy: Risk minimization and cash generation are critical. To maximize the cash generated by a bond, Kessler employs leverage, using those low rates in the repo market to borrow money cheaply. (Indeed, most individual investors could not pursue this strategy with anybody other than Kessler. If you have, say, a Charles Schwab account, the best rate you could get on a margin loan using U.S. Treasuries as collateral is 4.5%. Compare that with the 0.5% or less that Kessler pays. See box for more.)

Kessler then invests the money using an approach that layers multiple types of bonds without adding risk. So, for example, if a client tells Kessler he's willing to tolerate the risk of a ten-year Treasury, Kessler might divide the investment into three tranches of three-year bonds. The shorter-term bonds are less volatile, and individually they have lower yields than the ten-year bond. But by using the repos to buy more of the three-year notes, he's able to leverage the income so that it's significantly greater than what would be produced by the ten-year bond, without extra risk.

Not that Kessler's methods are without dangers. Like many bond portfolios, his are very susceptible to changes in short-term interest rates. U.S. Treasury bond prices plummeted 4.4% on a total-return basis in July alone, during the biggest rout in the U.S. bond market since 1981. Kessler's own benchmark, the Ryan Labs ten-year Treasury index, tanked 7.1%. Still, Kessler's clients lost only 2.5%. (They were in shorter-term bonds, which didn't fall as far. And the additional yield generated by their leverage also compensated for part of the price drop.)

Happily, since the repo market is essentially a day-to-day market, positions can be changed at a moment's notice, mitigating the chances of being hit hard by rising interest rates. And if you need to leverage, it's a lot better to do so with Treasuries as collateral than with anything else.

The Kesslers may live in the serenity of the Rockies, but their place sometimes has the raucousness of a trading floor. It is Sunday, and Lisa is banging a large wooden spoon on a copper pot. That's the signal for her 30 or so bejeweled and smartly dressed guests to convene at meticulous tables. Lisa describes the evening's meal: minted leg of lamb, a fresh ham with apricot brandy sauce, and steamed asparagus with orange butter. She reels off a list of every marinade, reduction, glaze, and garnish. "I am the Martha of the mountains," she quips, hands on hips. This is Lisa Kessler, chief entertainment officer.

Her professional title is financial principal and president of some of the Kessler company subsidiaries, but an important asset is her ability to schmooze. With more than ten years as a stockbroker at Bear Stearns, Dean Witter, and elsewhere, she has perfected the art of wooing clients.

As business partners, the Kesslers are determined to help people "get it." As guests mill around after dinner, Kessler retreats to the Steinway and plays a little Sinatra. Friends speak of "getting it"--that is, understanding Kessler's investment strategy. "I got it before my husband did," says one guest. The hardest part of "getting it" may be accepting that something so simple could make so much money.

"Robert should be a lot bigger than he is," whispers one dinner guest, weighed down by a gargantuan diamond ring. Perhaps. But till that happens, there'll be a few more mountains, and some more blood on the rocks, as Kessler continues toward his goal.

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