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By Jason Stipp | 07-11-2012 01:30 PM

Investing in a 'Beyond Difficult' Bond Environment

Despite safe assets looking truly overvalued, they still play a role in total portfolio construction, says JPMorgan Asset Management's global fixed-income CIO Gary Madich. Plus, hear Madich's take on opportunities in high yield, investing in munis, and using CPI swaps for inflation protection.

Gary Madich, CIO of JPMorgan Asset Management's global fixed-income group has called the current rate environment "beyond challenging" for bond investors. We sat down with Gary to learn about his take on the persistently low rates, the inflation environment today and why it might be a good time to buy inflation protection, as well as the risk-on/risk-off environment that investors are facing.

Jason Stipp: Gary, it still seems like we're living in a very much risk-on, risk-off environment. Just when Treasuries looked like the worst investment in the world, we see them rally again in the second quarter with 10%-plus returns on the long-term Treasuries.

In an environment like this, where we are seeing these flights to safety on macro concerns, how do you think about structuring, especially a fixed-income portfolio, when you can see very low-yield investments continue to gather assets as people are worried about the macro situation?

Gary Madich: Well, I think the first thing you need to do is, you really need to understand the thematic part of your process, i.e., you have to create some themes relative to the markets in which you are navigating.

Right now a lot of our themes, obviously, are built around trying to create portfolios in a low-return type environment. So, first of all that macro oversight process should act as a filtration system, really in any environment, but certainly most importantly right now--and then obviously drives your security selection.

When you're thinking about low returns in this environment, I think it would behoove people to, as we do, balance kind of a relative value return oriented mentality, which does focus on yield, with kind of a growth process, trend analyses and specific security analysis both intra- and inter-type sector. And when you do that, you tend to be less focused on the pure return, but on more the allocation process.

So, for example, a lot of people would suggest that, obviously, the safe-haven assets are truly, truly overvalued. We would agree with that. But that doesn't necessarily mean that we are significantly underweight Treasuries. We're underweight, but not significantly. We do see value in safe-haven assets like Treasuries from a standpoint of helping us at the total portfolio construction level with liquidity, managing our term structure, helping us hedge convexity, etc.

So, even in a low-yield environment where obviously we all thought rates were as low as they could go and then they went lower, we still have an appetite for Treasuries for the appropriate reasons.

Stipp: Gary, we heard recently from the Fed that they're going to continue to try to bring long-term rates down. We're also seeing easing, so-called quantitative easing, in other economies across the globe.

What is your strategy for managing a portfolio in an environment where we might see rates, because of policy measures, stay low for an extended period of time? How does that affect your interest rate outlook? And in the meantime, as rates are at these depressed levels, what do you do as an investor?

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