Wed, 29 May 2013
Given valuations and where interest rates are headed, you don't want a lot of market risk now, says Eaton Vance Bond manager Kathleen Gaffney.
Miriam Sjoblom: Hi. I'm Miriam Sjoblom, associate director of fund research at Morningstar, and I'm here today with Kathleen Gaffney, who is a portfolio manager at Eaton Vance.
Kathleen, thanks so much for joining us. You recently made a big career move late last year after being at Loomis Sayles for nearly three decades, and comanaging Loomis Sayles Bond for many years. You joined Eaton Vance. So we appreciate you coming to check in with us after making that big transition.
Kathleen Gaffney: Thanks, Miriam.
Sjoblom: So maybe to start out, you launched a new bond fund, Eaton Vance Bond, early this year. I think what a lot of our viewers would be interested in hearing is, what kind of strategy can investors expect from that fund? What might be some similarities or maybe some differences with Loomis Sayles Bond?
Gaffney: It's a multisector strategy, and the two parameters on it are a maximum of 35% below investment-grade and 20% in common stocks. So other than that, it's pretty much go-anywhere, which is interesting in this market environment, where people are looking for yield and income, to be able to find good opportunities across the markets. It's a similar strategy to what I've always down, but I'm working with a new team of analysts and traders, which I think will bring a lot of new ideas into the fund.
Sjoblom: One thing Eaton Vance is known for is its floating-rate loan group. Do you expect loans may play a bigger role in this portfolio?
Gaffney: We are tapping into the loan group, and I started the fund with about 10% in floating-rate [assets]. There has been such a demand in the market for income and yield, loans have participated in that. So I've actually been cutting back on the exposure. I think it's a great asset class for the medium term, but the market, primarily the new-issue market in particular, looks a little bit overheated, in that some of the advantages in the loan market in terms of LIBOR floors and the ability to hold on to that income, we're losing that with a number of repricings. So it's still there, but a little bit less exposure right now.
Sjoblom: You talked about valuations in the loan market, and this is something I think bond investors are dealing with across sectors after tremendous spread compression over the course of the last year. High yield is an area where you've traditionally invested. What do you think of valuations in the high-yield market today?
Gaffney: It is. It's a really tough market. It's a conundrum because we know it's a good time to take risk. Corporate balance sheets are in good shape, company fundamentals are improving, and the economy seems to be at an important inflection point. So you want to have exposure to those positive fundamentals. But given valuations and where interest rates are headed, you don't want a lot of market risk.
High yield, ideally, would be a great way to take credit risk and get away from rate risk. Unfortunately, those valuations, I think, have brought a lot of rate risk into the market. So I like high-yield-like securities, such as equity-sensitive converts, using the floating rate. And then in the corporate market I'm looking for more fallen angels or leveraged buyout credits that are trading cheaply because what's going to drive them again is the company fundamentals; get away from market risk now.
Sjoblom: You actually own common stock, as well.
Gaffney: I do. That's been another great way to capture good company fundamentals without taking on duration risk in the portfolio, and you're getting paid for it. Dividend yields are very attractive when you compare them with 10-year Treasuries. The average dividend yield on the stocks in the fund right now is just under 3%. That's a nice level of income, with potential to grow, and in some ways allows me to get exposure to the areas of the U.S. that are recovering that you can't capture in the bond market because valuations are tight.
Sjoblom: So you mentioned interest-rate risk and looking to avoid it. You are hearing some different views out there in the bond market that we might be in a lower-for-longer interest-rate environment. What are your thoughts?
Gaffney: With the economic data, at least recently, looking like it's slowing a bit that does make it seem [the bond market] is going to be lower for longer, which means there is going to continue to be a very strong demand for yield, and you should see spreads continue to tighten. That's great in the short term. I do think that we've got to be positioned for that potential rise in interest rates. I'm 100% sure that at some point rates are going to rise, and that's where you find the good values today, in those type of securities that will do well in a rising-rate environment.
Sjoblom: You also have the ability to invest globally. Can we talk a bit about maybe some of the risks that you're seeing globally?
Gaffney: The U.S. seems to be leading the developed world out of the financial crisis and into recovery. The emerging markets have benefited from the demand for yield, and also that perception that because they're growing faster, they're bit of a safe haven. We've seen a lot of supply, particularly in Asia, on the corporate side, both dollar pay, and more recently a lot of local pay. That is attracting yield-hungry investors, and I think it's a sign that whenever you see a tremendous amount of issuance, just pause and think "What's going on here?"
There is potential, with Japan jumping on the quantitative easing bandwagon, for inflation to take hold; not near term, but percolating away. And that's going to pose problems for some of these developing countries that need to have a handle on their monetary and fiscal policies, particularly in the face of rising wage growth, transitioning to more consumption, and managing inflation.
Sjoblom: What would you say to investors who are already in the Eaton Vance Bond, or those who are thinking about investing in the bond fund? How should they set their expectations going forward to own it successfully?
Gaffney: A multisector strategy is a great allocation for fixed income. In a lower-for-longer environment, where you're looking to pick up some yield and income, manage for total returns, so look to build a great long-term record. A when we get to that rising-rate environment, fixed-income investors are going to want to look a lot different than they have historically, that being broadly flexible and more opportunistic is a great way to generate some excess returns. Right now with my size, I'm very nimble and looking for great opportunities.
Sjoblom: Well, thank you very much, Kathleen, for joining us. It was good to hear your thoughts.
Gaffney: Thanks, Miriam.