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By Jason Stipp | 11-14-2011 12:00 AM

Fending Off Negative Returns in Fixed Income

Loomis Sayles Bond manager Kathleen Gaffney says the fund has combined a stake in high-yield and convertibles with exposure to Canadian and other non-dollar currencies to increase return potential, maintain liquidity, and prepare for eventual higher rates.

Jason Stipp: I'm Jason Stipp for Morningstar.

The stock market has been no easy place to invest over the last few weeks, but the bond market hasn't exactly been a walk in the park, either, with prevailing rates still low, given economic concerns out there. But there is also the specter of rising rates on the horizon.

Here with me to talk about how they're investing in this difficult environment is Loomis Sayles' Kathleen Gaffney. She is a manager on Loomis Sayles Bond, this is one of Morningstar's favorite funds in the fixed-income space.

Thanks so much for calling in, Kathleen.

Kathleen Gaffney: Thanks, Jason.

Stipp: First question for you, it has been a difficult environment for bond investing and bond investors, generally. We've seen on the one hand that a lot of managers are preparing for an eventual rise in interest rates, yet we've also seen that given market shocks and news out of Europe, there has been a lot of flight to quality, especially in the third quarter, where investors have piled back into Treasuries, and we've see long-term Treasuries do really well.

It seems like there are two countervailing forces in fixed-income today. How are you managing in such an environment?

Gaffney: It really is bit of a conundrum, given the volatility and that need for liquidity and a safe haven. What drives our strategy, however, is always what our long-term view is. And when I look at U.S. Treasuries, the 10-year yielding less than 2%, that doesn't give me a whole lot of good feelings about what the total return prospects are.

So you are earning very little in terms of income, and I know it seems like a long time off, but eventually we will see rising rates, and so potentially we're looking at negative returns.

So the challenge as a fund manager is to maintain the liquidity, which is what is desirable about Treasuries, but also insulate the fund from lower return prospects. So we really look for other alternatives that are higher return, [and] that's leading us into the credit markets, but in order to provide that liquidity and safety, what we've done is we are using Canadian government bonds. They are doing double duty in the fund right now in that we do like the currency long term, so that maintains our positive long-term focus, and it's a deep liquid market. So we are trying to avoid the volatility and the whipsaw, which is also a challenge in the Treasury market currently with all these ups and downs.

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