(MONEY Magazine) – FIDELITY LEVERAGED COMPANY STOCK FUND Assets: $108 million Load: None Annual expenses: 0.93% Phone: 800-343-3548 Website: www.fidelity.com Note: Data as of Feb. 14. Source: Morningstar.

David Glancy's portfolio needs a warning label: This fund is filled with hated, debt-laden companies. With holdings that have included AES, Qwest and Tyco, Fidelity Leveraged Company Stock fund reads like a who's who of stock market outcasts. In fact, Glancy invests mainly in the stock of companies sporting debt ratings of triple B or below--the edge of junk bond territory.

It's familiar ground. The 41-year-old Glancy has spent the bulk of his career investing in high-yield, sub-investment-grade bonds. He's run $3 billion Fidelity Capital & Income since 1996, and in December 2000, when Fidelity launched the Leveraged Company Stock fund, Glancy started steering his first equity fund. The ties to his junk days are still quite tight: Leveraged Company is the only Fidelity stock fund managed under the auspices of the high-yield bond group.

Since its inception, the fund has posted a total return of --1.7% vs. a 34% loss for the S&P 500. "All things being equal, the fund ought to do better than the S&P in an up market and do worse in a down market," says Glancy. The reasoning is simple. In good times, highly leveraged companies can earn big returns on borrowed capital. But when the economy and market sour, the same companies can falter under heavy debt burdens. That's why Glancy's performance is so impressive. He's outrun the market in what should be his most adverse investing climate. MONEY staff writer Adrienne Carter caught up with Glancy in Fidelity's Boston offices to discuss how his focus on debt-ridden companies has defied a bear market.

Q. If leverage works best in a bull market, how have you managed to beat the index over the past two years?

A. There are always things that are working in the market. Energy did okay over the past two years. Health care did okay. Plus, I've had several positions that have been multiple-baggers.

Q. Which ones?

A. Nextel, for one. In the 1990s they borrowed a lot of money to build a wireless network. Nextel's distinguishing feature was the push-to-talk phone that could double as a walkie-talkie. Their business model was one with a lot of financial and operating leverage. But they had bumps in the road in terms of execution. Then they brought in new management, and business really started to take off in the past 12 months. They executed well, and people finally saw it. [To investors] the company went from one that might have to restructure to the best cellular company in the U.S. That's why the stock went from $3 to $15. Now it's $13 or so.

Q. Still, it seems you can't go a day without reading bad news about a company you own. What's going on?

A. Leverage makes things go faster in both directions. When the market's going up, companies that have chosen to use leverage in their balance sheets will go up more. But it obviously cuts both ways. Recently we've had the perfect confluence of events with the recession and a crisis of confidence. Access to the capital markets has been all but cut off. Leveraged companies by definition are more sensitive to the ability to access capital. And when revenues and operating profits start to slow, that has an exaggerated impact on companies with debt. That situation has driven the performance of lots of companies.

Q. Driven it off a cliff. Are investors unjustly worried that such companies won't be able to pay their obligations?

A. If any one of us had to pay off the principal on our mortgages tomorrow, we'd probably have to scramble despite the fact that we're comfortably making our mortgage payments. That's the state of affairs in corporate America. Consumers with almost any credit quality have access to capital. But there is little access for most of corporate America. There is a lot of pressure on their business. Some firms have debt maturities where they owe principal in the next couple of years. The market is very concerned about where that money is going to come from even though [the companies] can cover their interest pretty easily. It's sign No. 1 that we're in a capital crisis.

Q. Any examples?

A. A lot of utilities companies have been hit. These companies have a regulated business where they're almost guaranteed a certain level of profit. They're comfortable enough to service the debt. But the market is spooked that they won't be able to pay these debts. Essentially that's what happened to AES. They had a very difficult debt refinancing, and the market was very concerned. The stock, which had been as high as $60, fell below $1. The bonds were trading at 40¢ on the dollar. As junk bond managers, we had a good sense of how that situation was evolving, and I think we were able to make some good purchases. By the latter half of 2002, they had completed their debt exchange. The stock got as high as $4.

Q. Where else is the capital crisis having an impact?

A. It's hit the entire airline industry, which is also suffering from deteriorating fundamentals. These stocks, save Southwest and maybe one of those new low-fare guys, could go bankrupt--or could quadruple from these levels.

Q. How has Enron affected the energy sector?

A. Lots of energy companies are under pressure. Big companies like Williams and El Paso have fallen into the high-yield universe. El Paso has billions and billions of dollars of diversified energy assets--pipelines, reserves and storage facilities--that are real. But they got themselves into some of the areas [like energy trading] that affected other people [such as Enron]. There are lots of companies in my universe now that have pretty low business-risk profiles that stubbed their toe on something tangential to their core business.

Q. So scandals and the weak economy expanded your investable universe.

A. The opportunities have never been better. The quality of companies has gotten better too. There are market leaders in every industry that are rated triple B or below. There's a lot of financial distress out there, and essentially that's a good thing for me.

Q. But how do you avoid the pitfalls?

A. Well, you don't really. In the end you need only three out of 10 ideas to work. They're going to more than offset the losers because the losers can all be down 100%, but the winners can go up four, five, 10 times. In leverage, you can lose all of your money. But your upside could be infinite.