Christopher Davis: You mentioned investors seeing cash in terms of just a safe haven, a place to keep their money in turbulent times. And when the market has gotten volatile investors have rushed into U.S. Treasury bonds.
Bob Brown: So if you thought that the 10-year bond was rich at 3% you were wrong; if you thought it was rich at 2% you were wrong. So it's a point well taken.
Davis: If you look at yields, they haven't been this low since the late 1940s, and if you look at what happened after that the next five, 10, and even 30 years, you lost money investing in Treasuries. So are government bonds even safe?
Brown: The answer is yes. I mean, from our perspective the U.S. government debt is safe, and we're quite comfortable with our holdings from that perspective. I think when you start to look at some of the eurozone peripheral countries, we do have a level of concern there, but we are not managing our bond funds today for rising rates anytime soon. So that's the first thing.
The second thing is that I believe that there is global systemic risk that will be with us and be with me for my career. That's not going away.
If you go back to 2008, you had a crisis management team of President George Bush, Treasury secretary Henry Paulson, and Federal Reserve chairman Ben Bernanke, and other members in Washington that used the Troubled Assets-Relief Program, a silver bullet if you will, and the bankruptcy of Lehman and the consolidation of other banking firms. They were able to confine the areas of concern and deal with it. You can debate whether it was right or wrong for the tax payers, but at the end of the day they did deal with it. In my opinion, they eliminated an Armageddon scenario for the U.S. financial system, and they moved forward. And you saw a real return in risk assets in 2009. It's certainly not without its problems as we face at the end of this year, but at the end of the day the U.S. dealt with their great depression.
So if you move that to Europe, and people need to understand that the euro, from a currency perspective is relatively at its infancy stage. It's 1/20th the age of the U.S. dollar, and the U.S. is considered the new world.
Given the economic challenges that Europe is facing and the significant credit events, the structure of the euro is being called out, the monetary union without a fiscal union. You have essentially 17 different economic models based off of one currency, and in periods of significant volatility you get divergence, not convergence. You have significant disparities and competitiveness and differences in unit labor costs, and when this is pegged to a fixed exchange rate there's no release valve from that perspective. You have a monetary union without a federal banking union. These are all significant issues.
We do believe that European leaders are hopeful that there's a greater, more federal Europe. And to do that you may need conditionality and you may have to surrender fiscal authority on some of the peripheral countries, but from our perspective, that's potentially a resolution. But this isn't the silver bullet of TARP and bankrupting a company and have others consolidate. This will take years. And as a result of that that we believe that there will continue to be this flight to quality, the U.S. dollar continues to be the reserve currency, and that Treasuries continue to be a safe haven for that type of volatility. As a result of that we think it's a strong part of a well-diversified portfolio to hold them.
Davis: When you think the yields can't go any lower, you can look at what's happening to German bonds. Recently they had negative yields.
Brown: Someone asked me about that the other day, issued a two-year German bund and with inflation built-in it was a negative return. But that security was actually $0.02 on that day, and the equity markets were down 2% -3%. So in periods of volatility you look for assets that go up, and given the current rate environment and the systemic risk, those are harder to find. So now you look for assets that hold their value, and that's why we believe Treasuries should be considered a strong allocation within well-diversified portfolio.
Davis: Speaking of equities, I have talked to lot of money managers. Not coincidentally they happen to invest in dividend-paying stocks, but they make the point that yields today on many equities are a lot more attractive than anything you can get in the bond market. What are your thoughts on the idea that investors who are seeking income should forgo bonds at least for a part of their portfolio and stick with blue-chip stocks that have really healthy yields?
Brown: I will answer it from the lens of managing the bond business, but also understanding the terrific work that Brian [Hogan, head of Fidelity's Equity Group] is doing in our equity group and the strong job that his team is doing in terms of delivering consistent performance. I will get to that. From a bond perspective I think what you have seen since '08 is this focus that tail risk is here to stay. The questions or the scenarios that you didn't think would play out actually are now part of your risk-modeling analysis, and as a result of that I think there will be a higher allocation to fixed-income securities and bonds. And we're seeing that in flows. We're having the best year in 10 years in terms of our net flows into our bond division, and there's a secular change there.
That being said, as we see the baby boomers, I don't know if it's 10,000 a day or 10,000 a week, but in terms of going into retirement they have their nest egg, they want income generation on it, they want wealth preservation, but they still want that capital appreciation. And I think that capital appreciation and income generation can be a blend of both fixed-income and equities. So that would be our outlook.
Davis: All right. Well, thank you for joining us today, Bob. I'm Christopher Davis with Morningstar.