Manager Insights
Third quarter Q&A with the portfolio managers
Rob Bloemker and Jeff Knight, 9/30/10
How would you describe the third quarter market environment?
Jeff Knight: Although the third quarter lacked some of the dramatic events that we saw earlier this year, we mostly saw a continuation of high volatility in stock markets and strong performance from most sectors of the bond market. For much of the quarter, fear of a double-dip recession plagued stocks. It only abated in September, when data signaled that the economy would continue expanding, although weakly, with unemployment remaining high for some time.
Rob Bloemker: Treasury yields rallied sharply as investors continued to prefer safe assets and, later in the period, as the Fed signaled the possibility of renewing its efforts at easing monetary policy, perhaps by resuming purchases of Treasuries.
What strategies did the Absolute Return Funds pursue?
Rob Bloemker: Recognizing the signs of economic weakness and the lack of conviction in equity markets, we pursued strategies seeking to limit volatility in several ways. Across all four funds, fixed-income strategies emphasized securities less vulnerable to the macroeconomic setting and backed by high-quality cash flows. Examples included commercial mortgage-backed securities and non-agency residential mortgages. Most of these holdings are senior securities protected from losses. In our view, they are poised to continue generating positive returns even if the real estate market deteriorates significantly.
Jeff Knight: The funds took advantage of fluctuating currency exchange rates during the third quarter. The U.S. dollar generally weakened versus the euro, the Japanese yen, and other currencies. Currency strategies offer an attractive diversification opportunity because they have low correlation with financial markets. In addition, to pursue their higher return targets, the 500 Fund and 700 Fund held positions in stocks and bonds from emerging markets, which are generally growing faster and, in much better financial condition than developed markets. The 500 Fund and 700 Fund also owned U.S. equities. We have been pursuing a "relative value" strategy, which favors stocks of companies that have solid cash flows and low financing costs. We have generally hedged these positions to reduce volatility.
What do you see on the horizon for the markets and the funds?
Rob Bloemker: For all four funds, we continue to see positive return opportunities in several sectors of fixed-income markets. Credit spreads have narrowed greatly since late 2008, yet they are still attractive by historic norms in many market segments. That is especially true in securitized sectors such as agency collateralized mortgage obligations (inverse IOs), non-agency residential mortgages, super-senior commercial mortgages, and corporate high-yield bonds.
Jeff Knight: In addition to fixed-income holdings, the 500 Fund and 700 Fund have positions in U.S. equities where we find attractive relative value. We believe U.S. equities remain fairly valued in absolute terms, and that they compare favorably with bonds in relative terms. Also, we are maintaining positions in emerging markets, which we find attractive on a secular basis due to faster economic growth and lower vulnerability to financial dislocations.
