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When the Stimulus Ends

Andrew Gogerty

Andrew Gogerty: Hi, this is Andrew Gogerty, Senior Analyst with Morningstar and joining me today is Mark Freeman, Manager of the WHG Income Opportunity Fund.

Mark, thank you for joining me today and taking time.

Mark Freeman: My pleasure.

Gogerty: Let's just start with the stimulus because obviously it is on everyone's mind. Obama just announced Bernanke was going to get a second term, and you know the stimulus had a lot to do with that. I am a curious to what you think about, at some point the stimulus package is going to end, they are going to start rolling it back, what's going to happen to government debt, Treasuries and agencies? What do you see happening there going forward?

Freeman: Yeah, that's a great question and I think in many ways we don't know the answer to that, but I do think that we know that we are going to be in a very interesting environment going forward, so I think specifically to the Fed, in terms of the role that they have played up to this point and specifically being active in the secondary market and purchasing assets.

So I think you have to look at it almost in two parts. The first part is you have to say, well what happens when they stop purchasing those assets and it seems that roughly October or by the end of this year depending on which program, we are fairly close to that and so we are going to see how does the market adjust to that taking place.

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The second part and probably the more interesting part is well what happens down the road when they actually want to remove the stimulus and a lot of the speculation is well, will they sell the assets back into the market and so that could have an impact on prices from there?

I do think that one of the things that is interesting to look at is that earlier this month Chairman Bernanke kind of laid out the Fed exit plan if you will and he listed four points, and the fourth point was selling of assets.

And I would say ... in terms of priority that's probably where it ranks from there. They have other options, other avenues, and I think we will see those exercised first, but again at some point that is going to be an issue for the market. But I think here in the short run or at least in the immediate future, it is probably not as critical as some people think, but it is something we have to focus and think about.

Gogerty: You had mentioned the short run. One of the other things was the rally this year in some of what you would call the risk sectors of the credit market, mainly high-yield corporate and investment grade bonds. Those have really come charging back the first part of this year, but going forward, is there really opportunity there. I mean how would you look at that from a relative value basis because they have come back pretty well?

Freeman: No, I think that's an understatement and as you know, when you look at the returns on high yield and really asset classes across the board, the returns speak to the compression of risk premiums, which is in effect what we are really talking about here.

So the question is, well can those risk premiums continue to come in from that and it gets back to the point we just talked about in terms of liquidity, so that's going to be critical to that I think. If liquidity stays plentiful, then that will also be supported, but to the extent that we actually see liquidity starting to be withdrawn from this system, then that is going to be a headwind for those asset classes.

I think the way we look at this is that going forward, it is really going to be driven by the fundamentals, and at this point, investors are going to have to go through each of those asset classes to really find the opportunities. It is not a question of, well, just this asset class is cheap or this one isn't. I think you are really going to have to go through and look within each asset class and say where are the opportunities.

And that ultimately is going to be a function of the fundamentals. And from our standpoint we would say is also going to be a function of quality. We think that going forward, at some point quality will be preferred and ultimately will be recognized by the market.