Morningstar Advisor - February/March 2009 - (Page 39) Associate director of fund analysis Lawrence Jones, vice president of equity research Haywood Kelly, bond specialist Eric Jacobson, and fund analyst Miriam Sjoblom contributed to this report. Municipal Bonds r Municipal markets were depressed by a crisis of confidence in the creditworthiness of municipalbond insurers, the failure of auction-rate securities markets, and significant sales of municipal bonds by highly leveraged market participants, involving so-called “tender-option bonds.” r Hedge funds that had taken advantage of the TOB structure unwound them in droves when plummeting markets and margin calls demanded that they sell their most-liquid positions. r As hedge funds and Wall Street departed the market and retail investors grew increasingly skittish, demand for the securities waned, putting pressure on prices. r Muni valuations relative to comparable maturity Treasuries are incredibly cheap, as are other measures of value, such as their yield comparisons to agency-backed mortgage securities. r Actual defaults in sector are incredibly rare. r Stick to high-quality munis for now. Nonrated and below-investment-grade sectors get hurt the most in a downturn. Consumer Stocks r In a consumer-led recession, the market naturally clobbers consumer stocks. r Given the U.S. housing crisis and generally high consumer debt levels, we agree that many areas of consumer—especially retail—will see a shakeout. Mortgage-Backed Securities r Headlines concerning agency balance sheets alarmed investors worldwide. r Investors dumped agency mortgages in droves and have remained on the sidelines, if for no other reason than the need to raise cash. r Bear market is hammering shares of several wide-moat consumer names that we think have very bright long-term futures. r We are focusing on a combination of lowerrisk firms that have dominant brands and slightly higher-risk firms with better long-term growth opportunities. r Yields of mortgages guaranteed by Fannie, Freddie, and Ginnie Mae are well above historical norms—even when adjusted for the theoretical value of their embedded refinancing options. r Fannie, Freddie, and Ginnie Mae mortgages carry what is effectively a government promise of protection. r Good values also exist in the nonagency mortgage-backed securities market, which is much less secure (with the lack of government guarantees) and has seen severe price declines. r Fidelity Intermediate Municipal Income FLTMX: Mark Sommer adds value through sector rotation, issue selection, and yield-curve positioning. r Franklin Federal Tax-Free Income A FKTIX: Sheila Amoroso buys and holds bonds offering competitive yields and trading at reasonable prices. r Vanguard Long-Term Tax-Exempt VWLTX: Fund’s cost advantage gives the offering a leg up in the muni world, where costs matter more than just about anywhere else. r Avon Products AVP: The firm’s restructuring efforts, international diversification, and strong returns on invested capital should allow its cash flows to hold up even in difficult times. r PepsiCo PEP: With its brands, product innovation, and a direct-store-delivery network, PepsiCo is the gold standard for the consumer-products industry. r CarMax KMX: Stock has gotten crushed, but we still think the company has a long runway of growth ahead of it. r PIMCO Total Return PTTRX: Bill Gross built a big position in agency guaranteed mortgage-backed securities and held firm against negative news. r TCW Total Return Bond TGLMX: Jeffrey Gundlach navigated through trouble by purchasing high-credit-quality mortgage-backed issues. r FPA New Income FPNIX: Bob Rodriguez and Tom Atteberry bought agency mortgage-backed issues, sticking to high-quality issues, because preservation of capital is foremost in their minds. MorningstarAdvisor.com 39 http://www.MorningstarAdvisor.com
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