Finding Ways Around the Rate-Free Risk

Laura Lutton: Hi. I'm Laura Lutton with the fund research group, here at the Morningstar Conference with George Gatch, CEO of J.P. Morgan's global fund business.

Thanks for being here today.

George Gatch: Thank you. Delighted to be here.

Lutton: J.P. Morgan has certainly benefited from all the flows we've seen to bond funds in recent years, and I'm wondering how you all are working to set investors' expectations given where we are with interest rates and valuations. How do we make sure that folks aren't disappointed after all this money is flowed into bond funds?

Gatch: It's something that we're very focused on with the 10-year Treasury at record lows. I'm not sure investors fully understand the potential risks that they're taking. When I grew up in the business, we used to refer to the Treasury yield as the risk-free rate. Now some call it the rate-free risk.

The returns that have been generated over the last decade in fixed income cannot be repeated mathematically, and what we're trying to do is help investors think about how they diversify more effectively on the fixed-income side of the portfolio. So, for example, many investors hold one, two, or three bond funds as a sufficient level of diversification, and given the number of options that are available, we think that [investors should have] a higher level of diversification particularly given what the potential economic outcomes are in the future.

The other thing that we're doing is talking to investors about rebalancing portfolios and developing a more balanced approach because of the level of uncertainty and volatility that exists. People have sought out perceived safe havens, and overall, we think investors should have a more diversified approach and develop a strategic asset allocation. [They should] determine how much they should have in cash, how much they should have in bonds, how much they should have stocks, and how much they should have in alternative investments. And then [they should] stick to a diversified disciplined plan over time and rebalance portfolios--particularly with the current level of volatility--on a periodic basis.

Lutton: Stick with it is often the hardest thing, right?

Gatch: Yes. That's exactly true.

Lutton: And alternatives have been a big emphasis in terms of product launches. Is there anything on the table that we should be expecting coming forward?

Gatch: We have a very robust product development capability, and there is a lot of focus that we're putting on investment products that can help investors insulate their portfolios from the risks in the marketplace. So this includes a range of capabilities for getting exposure to commodities as a very effective way of protecting portfolios against inflation. [It also includes] inflation-linked products and also more liquid alternatives to alternative products like market-neutral strategies. And there is a broad range of things that we're also looking at the fixed-income side, as well.

Lutton: And then speaking of product launches, you recently filed with the SEC for a new target-date series that features some exchange-traded funds and other investments. Tell us how this is going to be different from what you're already offering in this space.

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Gatch: Well, we have a series of target-date funds called Smart Retirement Funds, and they are very highly diversified with exposures to asset classes that we think will over time help insulate portfolios and protect them from the amount of risk and volatility we see in the marketplace.

What we're doing is developing another option for investors that includes exposure to many of the same asset classes, but also includes exposure to active portfolio management, as well as passive portfolio management. And the passive capabilities are designed in more efficient areas of the marketplace to provide a lower-cost option to investors. So you get less active management and cheap exposure to beta, and therefore lower total expense ratios. But the structure of the funds, the glide paths, the exposures, and the multiple asset classes that we're including are very similar between the two series of target-date funds.

Lutton: So, this is going to be the lower-cost option?

Gatch: That's correct.

Lutton: Great. We appreciate you coming in today.

Gatch: Thank you very much.

Lutton: Thanks so much. From Morningstar.com, I'm Laura Lutton.