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By Miriam Sjoblom, CFA | 01-03-2013 12:00 PM

Where to Find Future Winners in Corporate Bonds

Morningstar 2012 Fixed-Income Fund Manager of the Year Mark Kiesel says housing and energy sector bets proved positive last year, and he sees multiyear growth potential in these and other areas.

Miriam Sjoblom: Hi. I am Miriam Sjoblom, associate director of fund research at Morningstar. I am here today with Mark Kiesel, who is the portfolio manager of PIMCO Investment Grade Corporate Bond and winner of Morningstar's Fixed-Income Manager of the Year for 2012. Congratulations, Mark.

Mark Kiesel: Thank you.

Sjoblom: Well, thank you for joining us. Now, you've had a long track record at this fund, posting very good returns, but let's talk about 2012 specifically. And coming into 2012, can you talk a little bit about what your outlook was at the beginning of the year and how the fund was positioned?

Kiesel: Sure. Well, we were somewhat cautious on the overall economy as we started last year, but we did have a couple of contrarian views. One was banks, which not a lot of people wanted to own, and we held that position through 2011. And then in 2012 it turned out to be a very strong performer, one of the strongest performers in the investment-grade market.

Also last year, we embraced the recovery in housing probably sooner than some, and our exposure in building-materials credits, lumber companies, title insurance companies, and appliance companies proved to be very good for the fund.

And then finally, we also embraced the energy revolution earlier than some. And so we took advantage of companies that are growing earnings significantly faster than the overall economy and some of these midstream master limited partnership companies. So, it's really a combination of riding through the storm with the banks as well as really embracing the housing recovery and energy revolution maybe earlier than some other managers.

Sjoblom: You talked about being positive on housing early. Can you talk a little bit about your thesis and how you were able to get more comfortable sooner?

Kiesel: Sure. We spend a lot of time--obviously everyone's familiar with PIMCO's top-down macro. And on the macro front, I think what became very obvious was the inventories were coming down much faster than people thought. Right now today existing-home inventories of just over 2 million are at 11-year lows, and the new-home inventories are basically near 50-year lows. So, a lot of inventories have been absorbed into the market. The other thing is that household formation is picking up faster than what some people may have thought, given the decline in the unemployment rate.

And then what's happened is that prices for housing literally fell 35% from the peak. It's a combination of the fact that America has very, very cheap real estate--housing--and that supply and demand is changing. I think the biggest change came out of our bottom-up research, which we started doing over a year ago when we met with the homebuilders and building-materials companies. What became very clear was that consumer psychology at the margin was changing.

Specifically, people finally felt about nine months ago that housing would no longer go down in price. And that once you change that momentum, you would get demand to pick up, and that's actually what's happened. And so, our investment in the banks, in the building-materials companies, the lumber companies, like Weyerhaeuser, title insurance companies, appliance manufacturer Whirlpool, all those investments have paid off.

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