Morningstar Advisor - June/July 2012 - (Page 51)

Dan Fuss Vice chairman of Loomis, Sayles and Co. You cannot—at least, I haven’t found a way— get the bond prices to go up when interest rates go up. When we find it, I won’t advertise it. has to be filled by the U.S. dollar. So the non-U.S., non-Canada max is 20%. That means that the U.S.-dollar-based funds look quite a bit different than the others for us, but again, the same format that Michael just described; we just don’t have quite as much elbowroom. First place, Canada is where we have all but 2% of the reserves right now. We’re sitting in short Canadian Treasuries. A year-and-a-half is our stuff. The next big concentration is Australia and New Zealand together. And the rest is scattered throughout Southeast Asia and Norway, and a little tiny bit of Swiss franc in there. So that’s it on the currency side. The maturity of all of that is intermediate and shorter. Within the U.S. dollar, no Treasuries, so it’s corporates, and a couple of what were badly busted munis. The focus there is sort of a mix, but basically most of it is from high triple-B down into some single-B and some triple-C. We do have constraints on quality. We have to average investment-grade, and max is below 35% of assets, and that’s at 25% right now. We do have some concerns on the high-yield market. We also have an allowance to put 5% in common stock, which we’ve done. We built most of that up late last August, early September with just a handful of growing-dividend-type stocks. So, that’s how we’ve dealt with it so far. In terms of average maturity, I think at its peak, which was a while back, the bond fund had an average maturity of around 19 years. It’s now 10, and if you took the common stocks out, it’d be nine and a fraction. That’s a lot different than before. To bring that down any more would mean letting go of the monthly dividend, which would be hazardous to my health once the trustees saw it. Sjoblom: Hearing what the both of you are saying—Michael, you’re focusing more on currencies and not taking a lot of interestrate risk, and Dan, you’re adding equity-type risks with common stock and convertibles— is the key to successful bond investing in a rising interest-rate environment to just become less bond-like? Fuss: Yeah. Well, actually, it’s a wonderful environment. That’s a serious statement, but it sounds facetious. I grew up managing bonds. For my first 23 years of doing it, it was wonderful. Interest rates always went up. Every time you reinvested, you were reinvesting at higher rates. The value of the issuer’s call option, you could laugh at it. In other words, you didn’t have to worry about it. Then, for 31 awful years, interest rates went down. Now, we’re coming out of that. Hasenstab: I think it’s important for clients to focus on taking out a lot of the interest-rate risk in their bonds, and it’s going to mean substituting other risk. I like the way Dan said it: substituting specific risk for market risk. Whether it’s credit risk or whether it’s currency risk, there’s no way to get returns without taking some degree of risk, but when we balance those different components—interestrate risk, currency risk, credit risk—it seems to us that we’re getting better paid for currency and credit than we are for interest rates. The real challenge for investors is to make sure that their bond portfolio has the least amount of interest-rate sensitivity as possible to position for what we think the next part of this multiyear cycle will be, which would be higher interest rates. That’s not to say, though, that you can’t protect yourself. If you own short-dated bonds in Korea, paying three-and-a-half to 4%, and you can roll those over as they raise rates, you’re not necessarily going to lose money on a rising interest-rate environment. So there are ways to protect yourself, but it requires being very active, getting away from the index and looking at bonds a little bit differently. Sjoblom: Dan, you mentioned you have some concerns about the high-yield market. Can you talk about what those are? Fuss: Valuation, and the type of credits coming through, and the indentures. Now, when I discuss high yield, I throw bank loans in there, and we are using some bank loans. Not a lot, because you’re darned if you do, darned if you Now, clients don’t see it that way. The clients say, “Oh my goodness, interest rates go up, bond prices go down.” That’s true, so you have to prepare for that, too, and that’s where it becomes an art form. I’ve been giving some CFA speeches in recent weeks, and what works well with the CFAs is to say, “How to substitute specific risk for market risk.” That is actually what we’re doing to the degree you can do it with bonds. You cannot—at least, I haven’t found a way—get the bond prices to go up when interest rates go up. When we find it, I won’t advertise it. MorningstarAdvisor.com 51 http://www.MorningstarAdvisor.com

Table of Contents for the Digital Edition of Morningstar Advisor - June/July 2012

Morningstar Advisor - June/July 2012
Contributors
Letter From the Editor
Be Worth Remarking About
How Important Is Stewardship?
From West Point to Points East
Where a Fund’s Secrets Lie
Getting Fund Directors on Board
Managers Prep for Housing Rebound
Four Picks for the Present
Investment Briefs
A Hedge Against Career Risk
Natural Gas Reaches Capitulation
Family Matters
How Good Stewardship Predicts Superior Performance
Stewardship Goes Back to the Fundamentals
On the Go for Fixed Income
Where Shareholders Ride First Class
Dangers Lurk in Exchange-Traded Notes
Stocks on Sale in a Strong Market
A Good Steward Is Easy to Find
Our Favorite Mutual Funds
50 Most Popular ETFs
Undervalued Stocks With Wide Moats
Buffett Rule’s Biggest Losers

Morningstar Advisor - June/July 2012