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By Jason Stipp | 07-21-2010 01:12 PM

Dodge & Cox's Emery: Prepare for More Modest Bond Returns

The Dodge & Cox Income manager says investors may have undue expectations for fixed-income returns going forward, but GSE mortgages and select corporates do offer some relative opportunity.

Securities mentioned in this video
DODIX Dodge & Cox Income

Jason Stipp: I'm Jason Stipp for Morningstar. We are in San Francisco visiting with Dodge & Cox, and I am here today with Dana Emery from Dodge & Cox Income Fund, one of our favorite funds in the fixed income space. She is going to tell us a little bit about what she is seeing in fixed income and where she is finding opportunity. Dana, thanks for joining me.

Dana Emery: Thank you very much.

Stipp: On the first question for you, with interest rates still very low and risk aversion still very high, a lot of investors have been putting money into bond funds, they have been moving perhaps out of money market funds and moving into bond funds to get a little bit more yield; we have seen it in our fund flow data. With more money going into fixed income, has it been more difficult for you to find attractively priced opportunities in this space. And I guess a follow-up question on that would be given all the interest that investors have in fixed income, are there unrealistic expectations about what the performance of their bond funds might be?

Emery: Definitely, Dodge & Cox Income Fund has experienced similar types of flow. So we're definitely seeing a lot of flows into our bond fund, and we've seen interest rates come down pretty dramatically from the levels they were during the crisis. So the yield of our fund, for example, was around 8% in October of '08 and is now under 4%. So interest rates have come down dramatically, and that means the total returns in these funds have been very good.

So I think I share your concerns that perhaps investors will have undue expectations for returns, because of what has happened in the recent past. We think investors need to think about the starting yields of funds and right now intermediate bond funds are generally yielding less than 4%, the indices that we're measured by are under 3%. So you are starting from a very low base and returns from here should be fairly moderate. So I guess from our perspective, it really depends on your time horizon.

Stipp: On the valuation front, I am sure you're looking issue by issue and trying to find some opportunities in the market, has your opportunity set narrowed at all? I mean is it harder to find the kind of investments that you'd like to invest in because of valuations may be different now than they were a year or a year and a half ago?

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