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By Bridget B. Hughes, CFA | 06-22-2012 09:30 AM

Carlson: No Lack of Ideas in Emerging-Markets Bonds

Morningstar 2011 Fixed-Income Manager of the Year John Carlson says new debt issuance is high in the developing world, with plenty of opportunities in dollar-based bonds and a growing local-currency market.

Bridget Hughes: Hi, I'm Bridget Hughes, one of the mutual fund analysts here at Morningstar.  I'm at the 2012 Morningstar Investment Conference, and I'm sitting here with John Carlson of Fidelity. He runs the Fidelity New Markets Income and Emerging Markets funds, and he's done that since 1995 with a fabulous long-term record.

Thank you, John, for joining us.

John Carlson: Well, thank you, Bridget and thank you Morningstar for inviting me. It's my pleasure to be here.

Hughes: So we've heard a lot about emerging markets at this conference, about emerging markets being attractive both on the equities side and the fixed-income side, but it isn't as simple as just piling into emerging markets. There's a lot more to it. So, on the fixed-income side maybe you can talk about how you analyze and handle your interest-rate positioning and your credit positioning, and what other decisions that you have to make?

Carlson: Yes, thank you Bridget. I think that's a very encompassing question to start with. When you're looking at fixed-income markets, of course, interest rates, the term structure, all of that's going to be very important. Then we're looking at credit, as well, because we're dealing with sovereign, quasi-sovereign, and corporate issues, so we need to assess the credit dynamics in which way they're moving. Then finally, of course, we have the currency aspect because we're investing in both local markets and dollar bonds. So there's a lot that goes into it.

For example, last year I took the decision that I wasn't too worried about inflationary rates, so I extended duration. I looked at credit spreads primarily in the corporate market and decided that they were too tight given the relative value and took down the corporate position. And I felt that a lot of the emerging-markets currencies, both in terms of valuation and in terms of flows last year were completely overdone. So I stepped back from local currencies. So yes, there's a lot that goes into building an emerging-markets bond portfolio.

Hughes: Then duration today in your portfolio as you look forward is where?

Carlson: Well, duration is around seven years, so I've scaled back a little bit from last year, but last year if we were here, rates were, at the long end of the U.S. curve, 4.5% in terms of yield, and that's roughly where you are in Brazil today in 30-year debt. So we've come a very long way in terms of that. But I'm in the camp that long rates are going to stay lower for longer just as short rates are. I scaled back a little bit on duration, but I still have not really added meaningfully to either the foreign exchange or corporate credit product at this point.

Hughes: One of the standout characteristics of your portfolio versus your emerging-markets fixed-income index is your stake in Venezuela, and it's been something I think that's worked pretty well for you. Can you talk a little bit about the analysis that went into Venezuela and that you were going to overweight the country, and then where do you go from here?

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