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| Kathleen Gaffney |
Gaffney is a portfolio manager of the $3.3 billion Loomis Sayles Bond Fund in Boston. Roughly 60% of the fund is invested in domestic assets and the remaining 40% is invested in non-U.S. assets, 10% of which is in emerging market paper. The fund does not manage to a benchmark but compares itself to other multi-sector funds and the Lehman Brothers Government/Credit Index.
How are you allocated in emerging markets?
We have an an emphasis on Latin America and our largest positions there are in Brazil and Mexico.
So you're not concerned about spread widening in EM paper?
Emerging markets are attractive from a fundamental standpoint. There could be an inflation surprise in Brazil that would make it very attractive, especially in terms of diversifying away from a high-yield market where spreads are very tight. EM has solid fundamentals and our long-term view is there's opportunity there. Brazil is a top pick, there could potentially be double-digit returns if inflation surprises on the positive side which could outweigh the [global liquidity crunch]. Over the short term, leverage is moving out of the market but we look at leverage on the way out as a technical factor and long-term fundamentals are strong.
Is there an area of the market you find most attractive?
There is no silver bullet this year. That's why a multi-sector fund can find good sectors from a bottom-up approach and find where there's value and fundamentals. My answer is a multi-sector fund.
What does your corporate allocation look like? Do you see opportunity there?
On the U.S. side, we can go up to 35% in below investment-grade. I'd say we're at 25% in U.S. high-yield. In the corporate area we have a preference for high yield. In investment-grade corporates we don't have as high of an allocation, it's currently around 20% with a preference for triple-Bs. We like lower-quality stuff where you're paid for taking on risk, given the positive credit fundamentals. While credit is certainly getting cheaper the last couple of weeks, because in general spreads have come in so much, on the non-dollar side you can get some yield, like in a Brazil or New Zealand. We're being patient while we wait for the U.S. economic cycle to recover.
What's your outlook on the U.S. credit market?
I think it will go wider. There's a lot of leverage in the market that has got to unwind. It's doing so in fits and starts, there's a lot of liquidity that will take time to exit the market. I think they'll continue to gradually widen unless the carry trade unwinds quickly, otherwise in fits and starts. The tenor of the economy is strong but not robust--rates will continue to rise, but only to a modest amount. At some point rates will top out. In my crystal ball... I think it will be somewhere toward the end of this year.
Which areas are most vulnerable to spread widening?
High-yield and emerging market debt. We're being careful about buying and are investing in strong credit fundamentals. And we have been building up our cash position and holding Treasuries. We have 10-15% in cash right now and 5% is our normal to medium position. Spreads are tight and we're disciplined value investors, so we're holding Treasuries on the expectation spreads will widen. When the market sells off, we'll buy. We've seen the market overreact to events, such as the recent LBOs in retailers, which presents buying opportunities.
What's your view on General Motors?
We think it will be downgraded, yes. But it's less that GM is pushing spreads wider than that as rates go up, leverage comes out of the market. It has been coming out of credits on the cusp, so one aspect is not GM-specific. The high-beta names have more leverage that is unwinding.
What's your view on default rates?
I'm not overly concerned. My expectation is they're bottomed out but aren't going to dramatically rise. We're looking at a 2% default rate. If you look at the big issuance, we have another year or two before we're concerned and it will have an impact on the high-yield market. That being said, we're avoiding very low quality and triple-C sector paper. That part of the market, in '06 and '07 default rates become a risk, but not a near-term risk.
Where do you see value in higher-quality paper?
Our investment-grade credit side has declined as our higher-quality non-dollar component has risen. We barbelled our shorter duration and had been selling longer corporates and moving into the two- to five-year non-dollar pools. We've been moving into Canadian and some short-term New Zealand paper, the idea being we go up in quality and build in some yield. We've lost some of that advantage as rates have gone up, but we're being patient.
We like New Zealand for higher yields and its proximity to the high-growth area of Asia; we think its currency will profit from that. Canada is another commodity currency that is benefiting from strong oil prices and their balance sheet is in much better shape than the U.S. It's a very attractive currency to us.
In Europe, we have been in the euro but mainly in U.S. companies like El Paso, AT&T Corp. and Xerox. Most of the European currencies we like are peripheral. The euro looks overvalued, but we're also expecting a weak dollar as flows move around the globe. Asian currencies should see some appreciation, though it's difficult to find currency opportunities with yield. There are some opportunities in Singapore and Thailand. In Singapore, we like General Electric and McDonalds. There's a lot of high growth in that region. Buying can earn 4 1/2 to 5% in returns, which may seem boring in retrospect to the last two years of returns.