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By Sumit Desai, CFA | 06-25-2015 11:00 AM

Liquidity: The Greatest Risk Facing Bond Investors Today

Liquidity is not as robust as it used to be, but the asset management industry has continued to grow, creating new issues for fixed-income investors, says Janus fixed-income CIO Gibson Smith.

Sumit Desai: Hi, I'm Sumit Desai, senior fixed-income analyst with Morningstar's Manager Research Group.

Joining me today is Gibson Smith, fixed-income chief investment officer for Janus. Gibson is the lead portfolio manager several fixed-income funds including the Silver-rated Janus Flexible Bond Fund and the Silver-rated Janus Balanced Fund.

Gibson, thank you for joining me today.

Gibson Smith: Thank you for having me.

Desai: We talk about your strategy a lot and how you approach the fixed-income market. We use the term, and I think you use the term a lot, of "sector rotation." Can you talk a little bit about that? What are the data points that you look at to decide when to shift toward a more defensive or aggressive stance within your portfolios, and what are those signs telling you today?

Smith: Our two core tenets are risk-adjusted returns and preservation of capital, and to achieve those tenets we feel there are times to take risk and times to not take risk.

When we're looking at markets, we're paying very close attention to valuations, where the opportunities are in the marketplace, and we're letting our bottom-up fundamental process guide us toward those areas where we can generate returns for investors.

That means there are times where we will be opportunistic in our investing approach and other times that we're defensive in our investing approach. Right now is a period of time where we're being much more defensive.

Desai: When you say defensive, what does that mean, and specifically, when you think about risk within the fixed-income markets, we think about interest rate risk and credit risk among other things. How do you think about defensive positioning considering both of those factors?

Smith: Excellent question. When we look at the market, the wonderful thing about fixed-income investing is that it's a mathematically based product. We can calculate expected returns and outcomes in the marketplace. Within that context, we can see where the best opportunities are in the marketplace.

Today valuations are stretched. Yields are low. Spreads are tight. So, there is not a lot of opportunity for return, but there is a lot of opportunity for downside. So, we believe that it's a time to be more defensive, more cautious in our investing. Let security selection still drive the returns in a portfolio but add insurance and be careful in the portfolio as we approach these volatile markets, and again, a stretched valuation environment.

Desai: One of the hot topics within fixed income is divergence of rates and central bank policy across the globe. Can you talk a little bit about how investors can navigate through a lot of this volatility that some of this confusion has caused?

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