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By Jeremy Glaser | 04-15-2013 12:00 PM

Protecting Capital in Today's Bond Market

FPA Income manager Tom Atteberry talks about overvaluation among fixed-income assets, the risks of investing in Treasuries, long-term preparation for inflation, and more.

Securities mentioned in this video
FPNIX FPA New Income

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. I'm joined today by Tom Atteberry; he is the portfolio manager of FPA New Income. We're going to look at some risks facing bond investors today and also what he is doing to protect capital in this environment.

Tom, thanks for joining me today.

Tom Atteberry: Thank you.

Glaser: Let's start by looking at Treasuries. How do you think about the attractiveness and general valuation levels of government bonds today?

Atteberry: Let's start with the Treasury market. Where am I today? What am I looking at? And that's where the distortion and the difficulties start to show up pretty rapidly because you look at the situation where say, I'm just going to use as an example a 5-year Treasury at the end of the quarter had a 77-basis-point yield. But if I look back at history and I go back on to Fed website and looked at what's been the median yield for a 5-year Treasury looking at a cost-to-maturity Treasury index, I can go back January of 1962, and that number is 609 basis points. So, wow, a huge difference. So then, you go further and go "What am I really looking at whether I make a stock investment or a bond investment?" I'm trying to make some return greater than inflation. I'm trying to get a real return. Obviously, the more risk I take the higher to real return I'm supposed to be receiving.

That 5-year Treasury historically is about 250 basis points, or 2.5% real return. In today's environment it's negative. So, you already are looking at fact that you've got a large distortion of real return versus historically, and you go "OK, the base place I start with interest rates is overvalued and by a fairly significant amount."

Glaser: So, if investors think of Treasuries as being this kind of safe-haven asset, it sounds like you wouldn't agree with that, you think that there is more risk in Treasuries today than possibly elsewhere?

Atteberry: Yes. So, the first thing you realize, the safe haven, which is where I took no credit risk--I took interest rate risk, right, depending how far out on the curve I was--but I was receiving a positive real return, and thought "OK." But depending what my view was, of where I thought rates are going to rise, or were they going to fall and what the absolute level was to begin with you, I sort of went "OK, I can engage what interest-rate risk I'm wanting to take," but now you can't do that because you realize you are also accepting a negative real return to begin with, which historically you said that doesn't make sense. It should be about 2.5%. Right now, it's depending on how one wants to look at inflation, we'd issue as a Treasury Inflation-Protected Securities bond, as just a general element, a 5-year TIPS Bond is sort of a roughly 1.5% negative real yield. So, your whole premise, your whole basic building block of looking at the fixed-income market is distorted and overpriced.

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