Distinguished Speaker Series: Kathleen Gaffney, CFA, Co-Director of Diversified Fixed Income, Eaton Vance

The Distinguished Speaker Series featured Kathleen Gaffney, CFA, and Co-Director at Eaton Vance who focuses on fixed income. Eaton Vance is one of the oldest and most distinguished investment management firms in the United States.  Gaffney warned that the “end of the era” of low interest rates is at hand and that more volatility will be the result.

The increase in volatility is due to more than just the expected rise in interest rates.  Gaffney warns that the broker/dealer community has been hard hit by new capital rules that prevent them from holding large inventories of bonds.  Due to the global financial crisis of 2008-2009, this “shock absorber” has been taken away.  Gaffney stressed that moving capital will be difficult, leaving the market vulnerable to sharp corrections.

Gaffney stated that she is convinced that the credit markets are ripe for correction.  The FED’s actions will most likely impact short and intermediate term bonds the most.  If the FED does not begin to tighten in June, it will be accused of being behind the curve. She believes that the fundamentals in the United States are good and that once rate hikes begin; the resulting yield curve will resemble a “bear flattener” as short rates will rise faster than longer term rates.  Inflation will result when economies outside the US continue their economic recovery.

Gaffney is convinced that duration risk is the greatest risk facing the US bond market.  It is her position that US interest rates are too low and that the 10-year treasury yield will approach 4% by year-end.  She also believes that high-yield and investment grade corporate bonds are currently expensive. In this environment, as part of a multi-sector strategy, Gaffney utilizes dividend paying equity substitutes in her fixed income portfolio.

Gaffney purchases equities that yield between 1.5% and 3.0% at prices that are more reasonable than current bond prices.  These equities have yields that currently compare favorably to the 10-year treasury.  The equities market at this time also offers more liquidity than fixed income markets, and she is able to use up to 20% of her portfolio for equities.

In the brief question and answer period that followed Gaffney stated that she is an optimist and that strong GDP numbers which she expects in the near future will be a catalyst for rising interest rates.  She assigns a 0 duration to the equity positions she holds in her portfolio. It was interesting to hear how a multi-sector strategy allows her to include equities in the search for yield.

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