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By Jason Stipp | 04-11-2013 04:00 PM

Rivelle: Fed Casting a Very Long Shadow on the Bond Market

To the extent that the Fed has been the helping hand of the bond market, when that helping hand is removed, conditions are likely to change considerably, says Met West CIO and manager Tad Rivelle.

Jason Stipp: I am Jason Stipp for Morningstar. It is the future of Fixed Income Week on Morningstar.com, and we are checking in today with Tad Rivelle of Metropolitan West to get some big picture ideas on where the bond market may be headed. He is also a co-manager on our Gold-Rated fund, Metropolitan West Total Return.

Tad, thanks for calling in.

Tad Rivelle: Thank you so much. We appreciate the opportunity.

Stipp: The first quarter for bonds was a somewhat tepid quarter, starting off 2013, yet, we still saw some investors were putting money to work in fixed-income funds, and of course the flows into fixed income funds have been, as you're aware, pretty tremendous in recent times.

So, I am wondering at this point, given that we saw bonds pull back a bit or at least have a tepid performance in the first quarter, what are the right reasons for an investor to consider investing in fixed income, maybe in a fund such as yours, and what are some of the wrong reasons for investors to be putting money to work in fixed income?

Rivelle: Well, after three or four years of debt-induced quantitative easing policies and zero rates, obviously, we find ourselves at a point at which so much of the fixed income market is priced at, really, yield levels that are almost absurdly low, certainly below their long-term equilibrium, and in many cases they represent negative real rates.

So, the wrong reason to be investing in bonds--or at least a diversified-bond type fund--is with an expectation that you are going to see anything like the kinds of returns that you've seen in prior years. Obviously, we've lived through in an environment where a couple of years ago, 2011, the Barclays Aggregate, a broad measure of performance in the fixed-income market--a little bit like the S&P 500--was able to put in returns along the lines of 8%, last year it dropped to about 4%. And thus far, as you pointed out, we are tracking an annualized return rate of about 1%.

So, what are right reasons? Well, one of the right reasons is because bonds still carry positive relative to cash. We are still living in a world of financial repression. The Fed is utterly committed to a continuation of its policies that are holding down interest rates. And as a consequence, at least for now, one is able to earn some incremental return, and I think that relative to the 0% cash, it is still not bad, particularly when you consider asset classes such as non-agency mortgages and leveraged loans and some emerging markets, at least in relation to some of the poorer-priced asset classes, like Treasuries.

Stipp: And when you see the kinds of fund flows that we have seen into fixed income, do you think that the reasons behind them are valid? So, as you said some folks who maybe were in cash and seeking a little more yield have moved into fixed income. Maybe some who are worried about the stock markets have moved into fixed income. Do you think fixed income is sort of overbought, or that people are over-allocated, just because we are seeing tremendous money flow into that asset class?

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