Recipes for a Tough Fixed-Income Environment

Levin: They are going to get way better than they are anywhere else.

Benz: Okay, so I want to discuss Treasuries with you. Bill Gross has been trash talking Treasuries. How are you approaching Treasuries in your client portfolios?

Levin: We're generally keeping our durations pretty short. We do own some PIMCO Total Return. We don't own as much of PIMCO as we did a year ago or six months ago. So we're not excited about long-term Treasuries in any way, shape, or form. We'd rather have much shorter duration kind of investments. The problem is, again, I would say, you can't chase yield. So, if Treasuries aren't paying anything, you almost have to live with it and find alternatives that are reasonable but not so aggressive that you're forgetting the purpose of why you're investing.

Benz: So, are you concerned in lightening up on Treasuries that in a real market shock nothing else in your portfolios will perform as well as those Treasuries would?

Levin: You know, if I learn from the past, my answer would be yes, right? Because that's exactly what happened in 2008.

Benz: Right. It was the only thing that held up.

Levin: ... it was the only thing that did well. Cash will do fine in a market shock. We think some of those alternatives will hold up pretty well in a market shock. So, we do have dollars in places that won't generate real returns, but won't lose that much, and I think that when you think about how much Treasuries would have to gain, even in a market shock, to have any kind of meaningful return on a portfolio, I don't think it would be significant enough.

Benz: Okay, and does your pessimism about Treasuries extend to TIPS as well?

Levin: TIPS have a negative yield. In 2008, end of 2008, we were buying TIPS directly on the secondary market, and we were getting over a 3% real yield. We sold out of those about nine months or a year later just because other bond areas had greater opportunities, we thought, so we were being offensive with bonds. The negative yield on TIPS--we don't know when inflation is going to come back. We don't think that it's going to come back anytime soon. We think we'll be able to see it when it starts to come. So we're avoiding that category.

Benz: Okay. Now, a lot of people have been talking about dividend-paying stocks as a fixed-income alternative. Is that something that you are applying to portfolios as well?

Levin: We are, but more in the sense just from a relative value standpoint. So, we think high-quality companies, the kind of companies that Jensen J, for example, mutual fund would buy. We think they are going to be attractive going forward. We're at the low end of our small-cap holdings; we're at the low end of our mid-cap holdings just because those things have done so well, and we're mean reverters. So, we're buying dividend-paying stocks almost not on purpose, but that's because that's where the value rests because they haven't done as well as other kinds of stocks in the last couple of years.

Benz: How about other income producing securities like MLPs and REITs? What role are they playing in your portfolios?

Levin: They are not.

Benz: They are not...

Levin: So view MLPs and REITs as alternatives, and again we think that the problem with both of those investments is that they have such stock-like characteristics that if the stock market falls, we think they'll go with them, and we think because of the yield and some of the yield-chasers, they are expensive and their value just isn't there where it's been in the past.

Benz: Okay. Well, thank you, Ross, for sharing your insights.

Levin: Thanks, Christine...

Benz: We appreciate you being here.

Levin: Appreciate it. Thank you.

Benz: Thanks for watching. I'm Christine Benz for Morningstar.com.