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By Michelle Ward, CFA | 02-01-2013 12:00 PM

Is the Door Closing on Corporates?

Western Asset manager Ryan Brist expects a lot of risk in the corporates market in 2013-14, as banks pare risky lending practices and opportunities to enter or exit the bond market shrink.

Michelle Canavan: Hi, I'm Michelle Canavan, mutual fund analyst at Morningstar. I'm here today with Ryan Brist, head of U.S. investment-grade credit at Western Asset Management and lead manager of Western Asset Corporate Bond.

Thanks for joining us today, Ryan.

Ryan Brist: Thanks, Michelle.

Canavan: I thought maybe just getting started, Western has always kind of been known as a credit-focused fixed-income shop. Can you maybe just talk about what you think sets your team apart from your credit research and management capabilities?

Brist: I think you're right. I always tell our clients and consultants that when you manage credit portfolios, when you manage a portfolio of 80 to 110 different companies, you have to have the resources to do it right. And one of the things I'm most proud of about Western is that we have 34 people dedicated to research on a full-time basis. It's a very senior group actually. The average tenure is 17 years in the credit market. I think that their focus on management and some of the more subjective kind of qualities of evaluating credit really comes through and ultimately hopefully through our returns for our clients.

Canavan: Speaking of returns, 2012 was a really great year for Western Asset Corporate Bond. Maybe you can talk about how you were positioned going into the year and your outlook and kind of the things that really generated that great return.

Brist: We did have a solid year. I appreciate you acknowledging, and I say humbly that we had good year. But at the same time we're very proud. I think of 2012 as kind of the year of where the sun, moon, and stars kind of aligned together, and I'd first start by saying that that's a rare occurrence that that happens.

If you looked at our attribution of returns, we had pretty good security selection. We were in the right sectors, and we were down in quality relative to our benchmarks. And that added returns. The attribution of returns kind of along those lines, our main overweight was in the bank and financials sector. We were willing to be down in the capital structure in hybrid and trust preferred securities where we felt very comfortable from a research perspective. The simple story was that loan losses are less on the bank balance sheets. There has been undeniable balance sheet improvement and less risky activity by the banks. That kind of all culminated into tighter spreads in the sector. Over the last kind of two to three years, Michelle, it's been a really unpopular and uncomfortable bet to be in, and I think back to your Western question, I think that's where we really kind of try and distinguish ourselves, within our really tight risk framework. We like to be in sometimes those uncomfortable and unpopular areas of the marketplace, and ultimately they pay for our team.

We were pretty neutral in 2012 in the industrials sector, and that's where our kind of research team really kind of honed their skills. I think that there was a lot of acquisitions within industrials. Industrials weren't the cheapest sector but there were a lot of good situations, like Eaton Corporation bought Cooper, Ecolab in the chemical sector bought Nalco, Rock-Tenn which is in the paper and packaging sector bought Smurfit-Stone. And in each of these situations, a company did a strategic acquisition where they temporarily increased the leverage of their balance sheet. I think that our research team kind of really had a chance to evaluate the strategic nature and if we agreed with the strategic nature of the acquisition. Each of those acquisitions was associated with a bond issuance. And we capitalized on those, and those paid us. They aren't as valuable now in the marketplace but they paid our portfolios in 2012.

Lastly, I'd mention that we were really underweight electric utilities and technology. Electric utilities, there's a little bit of a arms race in renewable resources, and we think not only in the U.S. but around the globe electric utilities have big capital-expenditure budgets in the next three to five years. So that means there's going to be great supply in bonds, and we're going to have an opportunity. Maybe a company will make a mistake, and it will reprice the sector. Our analysts also did a pretty good job, Michelle, in terms of situations like Dell and Hewlett-Packard in technology. We had almost zero exposure to the technology sector in 2012. And you know what we do in the bond market--our number-one M.O. is to try and avoid principal loss or decline in price and avoiding sectors--the technology sector really paid us in '12.

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