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Q.Do you see more opportunity in international bonds?

A. We have a negative view on the dollar, especially versus emerging economies, which are raising interest rates to combat ination. I would emphasize that this is a longer-term view, though. Over the shorter term, we are more cautious on emerging market currencies because investors have built up large positions in them over time. As those positions

Europe, and underweight agencies and asset-backed securities.

With yield spreads back to more normal levels or even tighter in some cases, it is a difcult environment to make money from xed income sec- tor allocation, unlike during the past two years. Having said that, market volatility should provide plenty of tactical opportunities as the global economy works through numerous challenges.


“With interest rates rising and yield spreads tight, we do not expect returns anywhere near what we have seen in the last couple of years.”


moderate, we expect to be increas- ingly bullish on emerging currencies.

In developed countries overseas, such as Europe, we would expect to see rates slowly trending upward, similar to the U.S.

Q . W h a t i s y o u r c u r r e n t s t r a t e g y ? A . W e a r e o v e r w e i g h t i n h i g h yield, specically in bank loans, which represent the higher-quality part of the market and whose oating rate nature provides some protection if rates rise. We are also overweight in local currency emerging market bonds. We’re neutral on investment- grade credit and mortgage-backed securities, both in the U.S. and

Q . W h a t a r e t h e k e y s r i s k s n o w ? A . O n e i s t h e i n a t i o n r i s k e m e r g - ing economies are contending with, which threatens growth. Second, as we get closer to Fed tightening, how will the Fed engineer its exit strategy, pulling liquidity out of the system quickly enough to contain ination, yet slowly enough to allow the economic recovery to take hold?

Another risk is the economy in general. The housing market is still in the doldrums, and unemployment is high. We also are focused on potential event risk in the corporate bond market, as high corporate cash levels often lead to M&A [mergers and

Strategic Income Fund Portfolio Divers As of March 31, 2011


Other 5%

Europe Corporate Bonds 11%

Emerging Market Bonds 17.5%

Bank Debt 15%

Global Treasuries

    • 7.5


      • U.

        S. Corporate Bonds


U.S. Mortgages 15%

U.S. Commercial Mortgage-Backed Securities 5%

High Yield Bonds 10%

acquisitions] activity. As investment- grade corporations engage in M&A, they typically take on more debt, which hurts their credit quality.

Global risks also extend beyond emerging market ination concerns. Geopolitical risk, European sovereign debt risk, and rising commodity and oil prices are just some of the potential roadblocks on the path to economic recovery.

Q.What impact will the turmoil in the Middle East and rising oil prices have on the bond markets?

A. There are somewhat offsetting factors here. Typically global turmoil leads to lower rates because Treasuries are often seen as a safe haven, and that is what we’ve seen lately. On the other hand, rising oil and commodity prices are often associated with higher bond yields as ination concerns rise. While lower rates have taken the lead thus far, as time goes on, rising com- modity prices could lead to upticks in headline ination and pressure rates higher.

Q.What should investors expect in terms of bond market returns?

A. With interest rates rising and yield spreads tight, we do not expect returns anywhere near what we have seen in the last couple of years. We see a coupon-clipping environment as a good outcome, with even less return if rates rise as we expect.

It’s likely that the high yield market will outperform investment-grade corporates and Treasuries once again, assuming the economy continues to improve. But the outlook for credit sectors is more uncertain as we get closer to liquidity being pulled from the system, particularly as valuations become less compelling. It seems prudent here to reduce risk, stay liquid, and tactically allocate around market volatility.

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