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By Jeremy Glaser | 11-14-2014 02:00 PM

Actively Managing Risk in Fixed Income

Adhering to a risk framework and prioritizing issue selection and position sizing are central to risk management at Gold-rated Metropolitan West Total Return Bond.

Note: This video is part of Morningstar's November 2014 Risk Management Week special report.

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. I'm joined today by Laird Landmann. He is the co-director of fixed income at TCW. We'll talk about how he manages risks in his portfolio.

Laird, thanks for joining me today.

Laird Landmann: Thank you, Jeremy.

Glaser: So, we hear a lot about risks in fixed income these days, from credit risk to interest-rate risk. When you're managing your portfolio at that level, what kinds of risks are you really thinking about and how do you manage those risks?

Landmann: For us, it really all boils down to how we're going to do versus the benchmark at the end of the day. I know investors would love us to think about absolute return risk combined with tracking error risk. It's nearly impossible to have multiple objectives for your risk management in that form. So, we really focus on building a portfolio that can outperform the benchmark with a reasonable risk profile versus the benchmark.

So, we're focused on obviously our positions versus the benchmark, how diversified we are, and how risk is being priced in general in the marketplace at a given point in time. So, we think a little bit differently than, I think, hedge funds and lot of shorter-term investors. And to us, risk is most profound when prices are high and rising and correlations are low--that's when the models are disguising risk for you. And we believe that when prices are lower and there is opportunity in the market, you shouldn't be afraid of risk at that point.

We've been trained in this market that you're supposed to have a certain type of tracking error, and I think that too little tracking error is a bad thing. If you look through the Morningstar Intermediate Bond universe, you observe that managers with tracking errors of less than 150 basis points generally have provided no alpha for the fee that they are charging, whereas managers that are sort of in the 200 to 250 range seem to be in the sweet spot.

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