Andrew Gogerty: Hi. This is Andrew Gogerty with Morningstar, and we're talking bonds and the fixed income landscape today, and I have the pleasure to be joined by Mary Ellen Stanek, the chief investment officer of Baird Advisor and the Baird Funds, and one of the portfolio managers from the team of the Baird Aggregate Bond Fund.
Mary Ellen, thanks for joining me today.
Mary Ellen Stanek: Thanks Andy.
Gogerty: Obviously, in the press that flows into bond funds have been tremendous this year, especially intermediate-term bond has definitely seen a lion's share of the flows, but it's been almost two years now since the swoon of '08. I wonder if you can give us an idea of what you're looking at in terms of framing expectations for investors going forward, whether it'd be potential policy concerns from the government or just the intricacies of the bond market, because the money obviously isn't slowing down.
Stanek: Sure. In terms of short and intermediate high-quality bonds, we think they still offer good value, selectively, but not the enormous compelling value certainly you had coming out of the very tough market environment that we experienced in late '08 into early '09.
That said, what we try to do is really set the expectations in terms of what's realistic, and how to invest in all-weather strategies for the short term as well as the intermediate and long term. And so the kinds of things we're emphasizing is keeping the quality of the portfolios high, keeping the underlying structure very predictable and consistent so that we can deliver for our shareholders a very consistent and smooth ride in terms of as the markets are very volatile in here.
Gogerty: You said volatility, one of the big volatile and big portions of the index in the market is obviously the mortgage market. Just given what's going on policy-wise--and it seems something about mortgages is in the press every day--what are you looking at in terms of opportunity, but also trying to protect or maybe mitigate risk in the mortgage portion of the market right now?
Stanek: Sure. About a third of the benchmark growth of market is pass-throughs, agency pass-through securities. And recently, up until recently, the federal government had a huge demand or buying policy on buying in those securities, causing them we think to get on a relative value basis quite expensive.
So how we're setting the portfolio up and investing is, we've got about two-thirds weighting relative to the benchmark, but we're using other types of mortgage and asset-backed securities that have very high-quality structures, very predictable cash flows that we believe will outperform the U.S. pass-through market.
Gogerty: You had mentioned the demand for mortgages, obviously the demand and the liquidity for Treasuries remains high, too, compressing the yields. We've heard many talk about this really being a yield-deficient environment right now. Do you think it's more important or what are you seeing in the market in terms of, should investors be focusing on yield or is yield taking a second seat to focusing on total return in maybe capital preservation right now?
Stanek: For us, we've always looked at the yield on the portfolio or the yield on individual bonds and how we can convert that to total return for our shareholders. So it's not one or the other; you shouldn't only look at the yield on a bond when it's being bought, or a fund, because there is a long way from converting that yield to total return. What we try to do is set together consistent strategies that allow you to convert those yields to total return.
So stepping back for investors, we look currently at the potential for total return on the portfolios. We see attractive yield advantages on our investment-grade portfolios, including the Baird Aggregate Bond Fund versus the benchmark. We're doing that by underweighting our Treasury position and using more of the corporate and asset-backed or mortgage-backed securities that offer additional yield but on the short and intermediate side of the portfolio, so protecting the downside risk, if you will, but offering investors a little more yield.
Gogerty: You said on the corporate side, financials as we were talking earlier is one of the places where you found more opportunity relative to the benchmark right now. I wonder if you can just give me a quick overview of what's compelling, whether it's the structure, whether it's the pricing, whether it's the risk control right now that you see in that part of the market?
Stanek: Sure. We have always been biased positively towards the financial intermediaries and one of the biggest reasons is, because inherently as a bondholder, our interests are aligned very nicely with management. Management needs to keep that investment-grade credit rating to continue to run the company, fund their own balance sheet. So we like that symmetry, if you will, between our interests as investors with the management team.
That said, we look currently at the additional value on the financial intermediaries, and it's quite attractive. It's not as wide as it was, but still on the wider side of what's available in the marketplace. We also believe all of the additional changes in the market, some of them forced by the regulators on the banks and the financials have only enhanced our position as a bondholder. We wouldn't necessarily want to be a shareholder in these companies because many of the actions are going to limit their earnings per share growth rates, but have enhanced our positions as a bondholder.
Things like you need to hold more capital, you need to limit your trading activities and the kinds of risks you're taking on as a company. All those are quite consistent in terms of protecting bondholder interest. So compelling value for the risk that we can take and very attractive points on the yield curve. We like that intermediate sector with a very steep yield curve and believe that the financial intermediary bonds offer us very good value.
Gogerty: Just quickly on the other side of the table of that, is there anything that the new regulations either imposed by the market or the government have dampened the appeal of that sector at all or have they structurally changed it for the negative for bondholders?
Stanek: Well, certainly, overall, whether you are bondholder or you are shareholder, you are concerned about the earnings of the company, and so certainly a lot of the activities will rein in the risks that these companies can take and potentially dampen their earnings growth rates. And so, certainly, we need to monitor that and follow that, but consistently with the risk that typically, historically, would be taken by the financial intermediaries, we think the moves have been actually quite supportive of bondholders.
Gogerty: Great. Thank you very much for your time. I greatly appreciate it.
Stanek: Thanks, Andy.
Gogerty: This has been Andrew Gogerty with Morningstar and Mary Ellen Stanek from Baird Advisor and the Baird Funds. Thank you for joining us.