Tip:
Highlight text to annotate it
X
[music]
[music]
[music]
[music]
[music]
[music]
[music]
[music] CONSUELO MACK: This week on WealthTrack, a
Great Investor bond manager who believes stocks could be the next big thing! Kathleen Gaffney,
of the award winning Loomis Sayles Bond Fund, explains why the 30 year bull market in bonds
could be coming back to earth and why stocks could be launching into orbit- next on Consuelo
Mack WealthTrack.
[music]
[music]
[music]
[music]
[music]
[music]
[music]
[music]
SPONSOR: The company keep is also the company we keep.
Together we'll provide lifetime guarantee income and investments solutions.
PROMOTION: Hello, I'm Consuelo Mack. I want to tell you about a new opportunity to watch
Consuelo Mack Wealthtrack before the program appears on public television.
As a subscriber you can see programs 48 hours in advance of the general public and also
find timely interviews and commentaries exclusive to Wealthtrack Premium subscribers.
go to wealthtrack.com for more information.
[music]
[music]
[music]
[music]
[music]
[music]
[music]
Hello and welcome to this edition of WealthTrack. I’m Consuelo Mack. You have heard it proclaimed
far and wide, and even by guests here on WealthTrack: the great bond bull market of our generation
is over. But is it? And if it is, where do we go for predictable income?
It has indeed been a great bull market for bonds and it has lasted more than a generation,
thirty years from the early 1980’s until today. During that period, interest rates
on ten-year treasuries plummeted from a high of 15.84% in late 1981 to a record low level
of around two percent recently- that’s a stunning 14% drop. And as it works in bond
land, when interest rates fall, the value of the underlying bond rises. So while bond
investors are getting less yield income, they have been getting impressive capital gain
appreciation from the bonds themselves. Over the last three decades, investors have received
a 9.4% annualized total return from ten year treasuries, not equal to but rivaling historical
returns of stocks, and absent their wrenching volatility and uncertainty.
And despite mounting pronouncements declaring the death of treasuries by prominent money
managers and pundits, in the last twelve months, 10-year treasuries have delivered a total
return of 15% versus 8.5% for the S&P 500. Is it any wonder that investors remain wedded
to bonds and afraid of stocks? But is this a case of rear view mirror investing? Are
individuals missing another generational market turn in the road ahead? In fact is it already
happening? Over the last six months, ten year treasuries have lost more than a percentage
point, while the S&P 500 has advanced nearly 26%.
Today’s Great Investor guest is a bond manager who- are you ready- believes a generational
shift in the markets is occurring and it favors stocks! She is Kathleen Gaffney, long time
co-manager of the Loomis Sayles Bond Fund, among other fixed income funds and accounts,
with bond legend Dan Fuss. Loomis Sayles is a WealthTrack sponsor, but Kathleen fits right
in with our other Great Investors. She and the Loomis Sayles Bond team have been recognized
with numerous awards for their outstanding long-term performance, including Morningstar’s
Fund Manager of the Year in 2009. I began the interview by asking Kathleen, why a veteran
bond manager such as herself, believes stocks could now be the opportunity of a generation?
KATHLEEN GAFFNEY: There are some important signals out there right now. The first one
I look at is treasury yields. They’re nonexistent. And when I compare that to dividend yields,
historically, that’s been a great entry point for stocks. And they’re washed out,
in some respects. People have been heading for the hills, actually heading into bonds.
Exactly. That, again, is another sign that as the U.S. economy continues to grow and
recover, there are great opportunities, and the valuations are very attractive.
CONSUELO MACK: Let me ask you about the 30-year bull market in bonds, treasuries especially.
Treasuries have been the major beneficiary of the fact that interest rates have been
down from 15% in the ‘80s, down to below two percent or around two percent today. So,
isn’t it possible, given central bank policy, which has been very easy around the world,
isn’t it possible that the bull market in treasuries could continue for several more
years?
KATHLEEN GAFFNEY: It is possible, but going from two to zero, and then thinking about
what’s around the corner, is a very unattractive opportunity. And we always like to think long
term. So, two to zero? Maybe we do get there, but what I see going on is a lot more positive
economic data, and that means, with all the liquidity, we’re eventually going to see
rising interest rates, and I want to get prepared for it now.
CONSUELO MACK: So, in preparing for it, is there a chance- and I know at the Loomis Sayles
Bond Fund, for instance, that you do tend to sometimes be ahead of the pack, not necessarily
to your benefit- so, I mean, is it possible, again, with the treasury calls that are out
there, and you’ve been out of treasuries now for how long?
KATHLEEN GAFFNEY: We have, a couple of years.
CONSUELO MACK: A couple of years. So you’ve missed some pretty significant rallies in
treasury bonds.
KATHLEEN GAFFNEY: We have. But we haven’t chased them. We haven’t gotten back in.
That proved to be a very smart place to be in the first quarter of this year, which I
think gives you some sense of what’s going to happen when rates do start to rise.
CONSUELO MACK: So Kathleen, your colleague and co-manager, Dan Fuss, at a meeting the
other day, basically said that we are in the foothills of higher interest rates. And the
foothills could last for quite a while. So, what does one do in this transition before
interest rates really do start going higher?
KATHLEEN GAFFNEY: There are lots of things that investors can do. And I think foothills
is a very accurate description, because it’s rolling up and down gradually, so within those
pockets, there are opportunities to find some good investments. They’re in equity or equity-like
securities, and they’re also in fixed income; not treasuries but in corporate bonds, we
see some great value that’s still there today.
CONSUELO MACK: What have you done at the Loomis Sayles Bond Fund to, basically to position
yourself for this transition that you’re anticipating? One of the things is you’ve
shortened the maturity, the duration of bonds, right?
KATHLEEN GAFFNEY: We have. And a great way to do that was by reducing our exposure to
investment grade credit. You’ve got some yield there, but when you think about the
absolute level, when interest rates do start to rise, you’re going to see potential negative
returns there as well. They’re becoming a lot more sensitive to how interest rates
move as opposed to being more sensitive to an improving economy.
CONSUELO MACK: This is an interesting point, because investors have been flocking to bonds.
They’ve gotten very risk averse after the financial crisis, and they’ve been flocking
to it, so everyone has been saying, you know, go to the highest quality, i.e., treasuries,
and also the investment credit, you know, the highest quality bonds. You have an interesting
point, which is that instead of being risk averse, it’s actually, could be quite a
risky place to be and, in fact, that if you’re worried about loss of principle, that you
actually are in danger of losing principle in investment grade bonds. Why?
KATHLEEN GAFFNEY: It’s simple math. We saw it in the first quarter. The ten year was
at two percent, and within just a short period of time, it went up 40 basis points to 240.
Returns for the index over the first quarter were a small negative. And that’s…
CONSUELO MACK: So these are the returns for the ten-year treasury bond?
KATHLEEN GAFFNEY: Yes, and using the government corporate index as a proxy. So we had negative
returns there, and that’s just a move of 40 basis points going from two to 240. As
the economy gets stronger we’re going to see more violent moves, and I think investors
are going to be unprepared for that.
CONSUELO MACK: But you mentioned that it could be gradual. So, I mean, what’s the risk
that it’s not going to be gradual? I mean how concerned are you that these foothills
could very quickly turn into very steep mountains?
KATHLEEN GAFFNEY: It’s the amount of time, so it’s gradual over a couple of years.
But again, in a short period of a couple of weeks, 40 basis points is a big move.
CONSUELO MACK: In the bond market, right.
KATHLEEN GAFFNEY: In the bond market. If we go out two or three years from now, as interest
rates start to rise, then the moves, I think, are going to be more significant, and it’s
going to be difficult to find the opportunities out there and get out of the way fast enough.
CONSUELO MACK: One of the things, as I just mentioned, that investors are very risk averse
right now, and they’re looking for safety and liquidity. So, if not treasuries, which
has always been the place that we went for safety and liquidity, where do you go for
safety and liquidity now in the bond market?
KATHLEEN GAFFNEY: We’re looking particularly at corporates, but in a slightly different
way than we would have in the past. So when I think about corporates, I’m talking about
investment grade, and also high yield. And as you mentioned, in investment grade, some
of that yield advantage has gone away. There’s not as much of a cushion. So we want to make
sure that when rates start to rise, we’re not exposed to that. So where else in the
investment grade arena do we see opportunity? And interestingly enough, it’s away from
U.S. shores; it’s in Europe, which might be a bit of a surprise.
CONSUELO MACK: That is a surprise.
KATHLEEN GAFFNEY: But when you think about where can I get that cushion, that real yield
advantage, there are investment grade quality companies in Europe, and I’m thinking peripheral
Europe, right in the heart and center of what’s going on right now, but in companies that
we think are going to continue to do well. Yes, there is definitely a debt crisis going
on, but corporations are going to continue. People will continue to turn the lights on,
to use their phones. We may see a deep recession, but we’re not worried about bankruptcies
here.
CONSUELO MACK: So you’re talking about, you say peripheral Europe- Portugal, Spain,
Italy.
KATHLEEN GAFFNEY: Yes.
CONSUELO MACK: And I’m sure our viewers are going, “You’ve got to be kidding?”
And you’re talking about what utilities and telecom companies in those countries,
so this is not sovereign debt, these are corporates.
KATHLEEN GAFFNEY: These are corporates.
CONSUELO MACK: And that’s where you would describe them as being liquid and relatively
safe?
KATHLEEN GAFFNEY: Not as liquid as treasuries, but if you’re looking for good long-term
returns, the yields there are pretty comparable to what we’re seeing here for high yield
credits. So in a stressful scenario you might see some downgrades, but you’re getting
compensated for that risk; you’re picking up a lot of yield. And what I like the best
about them is that when those spreads- the yields in the corporate bond relative to risk
free treasuries- begins to narrow, that’s most likely when the global economy is on
track and the issues in Europe will have been resolved. That spread will start to narrow,
and probably at a time when interest rates here are starting to rise. We’re always
looking for the type of bond that’s going to move in the opposite direction, particularly
when it’s rising interest rates that we’re talking about.
CONSUELO MACK: That’s very interesting. Before we leave treasuries, though, I want
to talk about-- at the Loomis Sayles Bond Fund you’ve got what, about 15% in… five
percent in cash and then another ten percent or so in shorter-term liquid securities?
KATHLEEN GAFFNEY: It’s our Canadian government bonds; we do.
CONSUELO MACK: So that’s what I was wondering. Are the Canadian government bonds, those are
the substitutes that you would use now instead of U.S. treasuries? For your liquidity cushion?
KATHLEEN GAFFNEY: Yes. I think that-- that position, I like to think of it as doing double
duty. It provides the liquidity if we need it, because we know there are risks that are
out there today, and the market, I think, is going to remain volatile, so we always
want to have that liquidity measure. But on top of it, we like Canada, the Canadian dollar
in particular. There is some appreciation potential there coming from global growth.
Canada’s got a lot of natural resources and we see that appreciation potential. So
if a bond can do more than one thing for us, we really like it a lot.
CONSUELO MACK: Now it’s interesting that you mention the commodity play, because I
know in the past when I’ve talked to you or Dan, that you have stressed some of the
commodity producing countries and their currencies. A lot of people are looking at China, which
is a major source of demand for commodities; they’re looking at a recession in Europe;
they’re looking at, yes, the U.S. economy is recovering but it’s recovering very slowly,
it’s still very modest growth. And they’re saying the commodity play is over. You disagree?
KATHLEEN GAFFNEY: In the long term I disagree. There will be volatility in commodities. But
if I hear everybody saying it’s all over, there’s probably a pocket of value there
that we can hold onto for the long term, so that’s one of the reasons we like Canada,
but also Australia, New Zealand. Again, developed world good guys, they’ve gotten the fiscal
discipline message, so their balance sheets, their country balance sheets, are in better
shape, and they’re leveraged to that global growth.
CONSUELO MACK: China has just said it’s going to allow more yuan-denominated issues
overseas, and so is that going to be an opportunity as well?
KATHLEEN GAFFNEY: What keeps us out of China is we always, as good analysts, want to make
sure that we’re getting information that we believe is reliable and we can understand
it. And until we get that type of information, we’ll avoid some of those markets.
CONSUELO MACK: So, China then is an area that Loomis Sayles is avoiding because of those
issues?
KATHLEEN GAFFNEY: Yes.
CONSUELO MACK: Lack of transparency.
KATHLEEN GAFFNEY: Yes. But we like the growth that we see there, so the way we play China
is to look at some of the peripheral currencies, or countries around China, so Indonesia, the
Philippines, and Korea, those would fit the bill that we think are good investments with
good appreciation potential in the currency.
CONSUELO MACK: So as we go around the world, Kathleen, peripheral Europe, high yield in
the U.S., right?
KATHLEEN GAFFNEY: Yes.
CONSUELO MACK: Pretty much? And then in Asia and Latin America, for instance, so take us,
where are you seeing the best values as you kind of take us on a trip around the world
in the global bond fund?
KATHLEEN GAFFNEY: Well, in terms of what I think is the best value today, right now,
because I think the U.S. is in good shape and moving in the right direction, yet interest
rates are lower. High yield looks very attractive, but with some caveats. So if you’re in the
high yield market, you want to know what you own, you want to focus on your issue selection.
So I like high yield for that yield advantage in the near term, and see those improving
fundamentals, but I’m careful. That’s got us looking at convertible bonds, which
many of are rated below investment grade, so it’s high yield but a different flavor
of high yield.
CONSUELO MACK: So let’s talk about the convertible space, because convertible bonds, you buy
them as bonds but they are convertible into a certain number of shares at a given price
within a given period of time. So what is it that’s so attractive about convertible
bonds to you at Loomis Sayles Bond Fund?
KATHLEEN GAFFNEY: They’re hybrid, so that you’re exactly right. They’re a little
bit equity, at times, and a little bit fixed income. We look for what are busted converts,
so it would be a high yield substitute. The yield is going to be similar to a straight
bond, meaning that equity option isn’t worth much. You’re looking at the credit. That
allows us to get broader exposure in below investment grade, in good companies, without
taking too much risk.
There are other converts which are more equity sensitive. And I like those because, as I
mentioned, the value proposition in equities is attractive, and we want to capture that
upside potential. A lot of companies are sitting on cash. The balance sheets are in good shape
and now they’re very focused on getting earnings going. We want to capture that, and
the equity option is more valuable. So in some of the companies that we’ve owned,
straight bonds- Ford is a good example- we see more opportunity on the equity side, and
they’ve got a convertible bond. That fits that profile. And also global companies that
can gain market share in this very challenging environment, and that might be something like
an Intel, so it’s an Intel convert that fits that bill, and gives us the potential
to participate in that upside, and again, at a point in time that might be when interest
rates are rising.
CONSUELO MACK: You said busted converts? Is that what you were calling-- what’s a busted
convert?
KATHLEEN GAFFNEY: So that’s where the stock has declined so much that the value of that
option to convert into equity at some point down the road, becomes absolutely worthless,
so you do look at it just as a bond, and very frequently investors as a whole will shy away
from the busted converts because it might be the only debut of the company that’s
outstanding. And for some people it’s not worth their while to take a look at it. We’ll
look for value no matter what shape or form it comes in if we think it’s got good total
return prospects.
CONSUELO MACK: One of the things that I was intrigued by, is a new fund that you’re
participating in, along with Dan, at Loomis Sayles. It’s called the Capital Income Fund,
and it has a minimum exposure of 70% in stocks- that’s a minimum exposure- and a maximum
exposure of 30% in fixed income. What’s the strategy there? And I’m wondering if
I can use that as kind of a proxy for maybe the way you think my portfolio should look,
with 70% equities minimum, and a maximum of 30% fixed income?
KATHLEEN GAFFNEY: It’s an attractive vehicle because of that mix of equity and fixed with
an orientation towards providing income, which all of us out there are struggling to find
these days with interest rates so low. Interest rates are low because we’re struggling to
get that growth, but it is going to come. It’s probably going to come with a cost
of inflation, but those strong earnings and the valuations make equity look very attractive.
Yet it’s not going to be easy to get through this transition, so we see a lot of volatility.
Investors may see the value, but are very fearful of the volatility. The income, and
particularly the yield from fixed income right now, provides some ballast to it, so you get
that exposure, which you know is priced appropriately, but you get a little bit more extra income
to help make it more defensive.
CONSUELO MACK: Here you are, a bond manager, and saying that the income opportunities on
the equity side, are really greater than they are in the fixed income side?
KATHLEEN GAFFNEY: The total returns are more attractive on the equity side in the long
term. The dividend paying portion of it on the equity side is attractive, and I think
will continue to be attractive. It may be more volatile, and that’s the important
part of having those-- we have higher yields from the high yield component. So many of
the bonds that we’re starting to populate that fund with, are much higher yielding,
and give it some defensiveness.
CONSUELO MACK: As a risk proposition, what do you think is more risky? Is it in the bond
market or is it in the stock market? Do you think the stocks are less risky now than bonds
are?
KATHLEEN GAFFNEY: Well, from a valuation standpoint, if you’re a long term investor, I think
you’ve got some great return prospects ahead, with a certain degree of volatility.
CONSUELO MACK: In which asset class?
KATHLEEN GAFFNEY: In equities.
CONSUELO MACK: In equities, in stocks.
KATHLEEN GAFFNEY: In equities, so I think you’ve got very good return prospects there,
with a measure of volatility. On the fixed side you’ve got some high current yield
right now, but your total return prospects are narrowing.
CONSUELO MACK: So it strikes me that maybe Loomis Sayles is making a real shift in its
view of which markets, longer term, now are going to be more attractive. Is that correct?
The firm is basically saying: you know what, as an asset class, stocks, 70% stocks minimum
in this new fund, that’s where you should be for income, and for total return?
KATHLEEN GAFFNEY: It makes a lot of sense, and then focusing on that fixed income portion
at 30%, it’s the makeup of it, that it’s primarily corporate securities, or non-dollar
securities. We are really getting away from market risk that interest rate sensitivity,
which I really think is an important message for investors out there. Interest rate risk
is increasing, and it will continue to increase as the economy continues to strengthen. You
want to protect yourself against those principle losses when interest rates do start to rise.
CONSUELO MACK: So the One Investment for a long-term diversified portfolio, what should
it be?
KATHLEEN GAFFNEY: Well, thinking about value, and thinking for the long term, I’m going
to highlight the home builder sector, the large public home builders. And I think you
could buy equities or bonds and be happy with the returns there.
CONSUELO MACK: Why the large, publicly-traded home builders? Which actually, at least from
the stock side, have done pretty well recently.
KATHLEEN GAFFNEY: They have, but they also took a pretty big beating over the last couple
of years. So to me that’s deep value. They have done well. And I think they will continue
to do well as the U.S. economy continues to slowly recover. There are a lot of bets out
there against it, and so I think you’re going to see these companies do well as the
U.S. shows the strength that it does have, and gets back on its feet. Housing is going
to be very important to the recovery of the U.S. economy.
CONSUELO MACK: And where in the, kind of the credit structure, would you, as far as a bond
investor, would you look in the home builders? I mean would it be in the senior credits?
Would it be in convertibles?
KATHLEEN GAFFNEY: That’s a great question, because most of the home builders right now
are related below investment grade, so they are high yield. It’s names like Lennar,
Kaufman and Broad, these are the public home builders. They’re below investment grade.
Some of them will come back to investment grade, and some of them have convertible bonds
as well. So you get that hybrid, a little bit equity, a little bit fixed income.
CONSUELO MACK: If the bull market in bonds is essentially over, the great bull market,
especially in treasuries, is over, and so many investors are invested in the bond market
for two reasons, they want income and they want stability. So what role should bonds
now have in our portfolios? How should we look at our bond positions and what they can
do for us? Is it still going to be income and is it still going to be stability?
KATHLEEN GAFFNEY: There’s definitely going to be income there, and in fact, as rates
start rising, at some point treasuries are going to be attractive. It’s the amount
that you have in your fixed income allocation that treasuries will offer some opportunity,
and you would want to add onto them as interest rates start rising, and that corporate securities,
with their higher yield advantage, are going to provide that important level of income
that everyone’s looking for.
CONSUELO MACK: Kathleen Gaffney, so great to have you on WealthTrack. Thank you so much
for joining us, with the Loomis Sayles Bond Fund.
KATHLEEN GAFFNEY: Thank you, Consuelo.
CONSUELO MACK: At the conclusion of every WealthTrack, we try to leave you with one
suggestion to help you build and protect your wealth over the long term. This week’s Action
Point is: follow the lead of Kathleen Gaffney and the Loomis Sayles Bond Fund and consider
convertible bonds.
Convertibles bonds are hybrid securities. They make regular interest payments, are senior
to stocks, and less volatile. But their price also participates in the underlying stock
price movement because they can be converted into a pre-determined number of common shares.
However, as Kathleen warns us, they are very complicated, so are best left to professionals.
Morningstar recommends the four-star Vanguard Convertible Securities Fund (VCVSX), which
invests in both U.S. and international securities.
Next week, we’ll be focusing on small company stocks from around the world with a Great
Investor who rarely appears on television. He is Whitney George, co-chief investment
officer of Royce and Associates and portfolio manager of several of the highly regarded
Royce Funds. If you want to see our WealthTrack interviews ahead of the pack, subscribers
can do so 48 hours in advance. To sign up, go to our website, wealthtrack.com, where
you can also watch past shows and find our One Investment and Action Point recommendations.
And that concludes this edition of WealthTrack. Thank you for watching and make the week ahead
a profitable and a productive one.
[music]
[music]
[music]
[music]
[music]
[music]
[music]
[music]
SPONSOR: Additional funding provided by: Loomis-Sayles - investors seeking the exceptional
opportunities globally. The Wintergreen Fund - your home for global
value. Research Affiliates - Efficient index foreign
inefficient market.
[music]
[music]
[music]
[music]
[music]