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By Jeremy Glaser | 04-12-2013 11:00 AM

Walsh: No Bond Bubble

There are fundamental reasons why rates are so low today, but that doesn't mean there aren't potentially significant risks to holding bonds, says Western Asset's Steve Walsh.

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser.

I'm very pleased to be joined today by Steve Walsh. He is the chief investment officer of Western Asset, and we're going to look at some hot topics in the fixed-income world.

Steve, thanks for joining me today.

Steve Walsh: You're welcome, Jeremy. Good to be here.

Glaser: So, we've seen a really substantial amount of flows into bond funds over the last couple of years. What do you think is driving that continued interest in fixed income? Is it a search for yields, or is it a search for safety? Why are investors allocating to bonds right now?

Walsh: Jeremy, I think it's probably a little bit of both. The one common factor across the world, really not just in the U.S., is we're in a very low, low interest rate environment, and you've got a world that to a large extent is pretty income-starved. So, I do think the moves into fixed income have been partly a desire to find some yield in a marketplace that doesn't offer it in cash. There is no really safe place to just put your money and not effectively lose money through inflation, so there is certainly a demand for yield across the world.

I do think given the last decade or so of fairly volatile stock markets that there is an element that is also driving these flows, which would be a demand for a little bit greater safety or security in their investments than what retail investors certainly have experienced over the course of the last 10 or 12 years in stocks. So, I think it's a combination of both of those.

Remember, I think especially if you look to the Federal Reserve, a desired outcome of their monetary policy is to get people to take more risk. They take interest rates down to zero to try to encourage people out the risk spectrum. They're getting the desired response, which is: Hey, I am earning zero in my cash, and I better go find another asset that might at least give me something.

So, that's sort of ripple effect across other sectors of the fixed-income markets is, again, exactly what the Fed is trying to do. And, again, you see interest rates below one in Europe, you see in the U.K. Obviously, you see the same thing for over a decade in Japan. So, I think all of that together is leading to just a lot of demand for fixed-income products, even at these relatively low yields.

Glaser: So do you think investors have reasonable expectations for the kind of returns they can expect in fixed income, or do you think people have outsized expectations there?

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