Kathleen, thanks so much for joining us. You recently made a big career move late last year after being at Loomis Sayles for nearly three decades, and comanaging Loomis Sayles Bond for many years. You joined Eaton Vance. So we appreciate you coming to check in with us after making that big transition.

Kathleen Gaffney: Thanks, Miriam.

Sjoblom: So maybe to start out, you launched a new bond fund, Eaton Vance Bond, early this year. I think what a lot of our viewers would be interested in hearing is, what kind of strategy can investors expect from that fund? What might be some similarities or maybe some differences with Loomis Sayles Bond?

Gaffney: It’s a multisector strategy, and the two parameters on it are a maximum of 35% below investment-grade and 20% in common stocks. So other than that, it's pretty much go-anywhere, which is interesting in this market environment, where people are looking for yield and income, to be able to find good opportunities across the markets. It's a similar strategy to what I’ve always down, but I'm working with a new team of analysts and traders, which I think will bring a lot of new ideas into the fund.

Sjoblom: One thing Eaton Vance is known for is its floating-rate loan group. Do you expect loans may play a bigger role in this portfolio?

Gaffney: We are tapping into the loan group, and I started the fund with about 10% in floating-rate [assets]. There has been such a demand in the market for income and yield, loans have participated in that. So I’ve actually been cutting back on the exposure. I think it’s a great asset class for the medium term, but the market, primarily the new-issue market in particular, looks a little bit overheated, in that some of the advantages in the loan market in terms of LIBOR floors and the ability to hold on to that income, we’re losing that with a number of repricings. So it’s still there, but a little bit less exposure right now.

Sjoblom: You talked about valuations in the loan market, and this is something I think bond investors are dealing with across sectors after tremendous spread compression over the course of the last year. High yield is an area where you’ve traditionally invested. What do you think of valuations in the high-yield market today?

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Gaffney: It is. It’s a really tough market. It's a conundrum because we know it's a good time to take risk. Corporate balance sheets are in good shape, company fundamentals are improving, and the economy seems to be at an important inflection point. So you want to have exposure to those positive fundamentals. But given valuations and where interest rates are headed, you don't want a lot of market risk.

High yield, ideally, would be a great way to take credit risk and get away from rate risk. Unfortunately, those valuations, I think, have brought a lot of rate risk into the market. So I like high-yield-like securities, such as equity-sensitive converts, using the floating rate. And then in the corporate market I'm looking for more fallen angels or leveraged buyout credits that are trading cheaply because what’s going to drive them again is the company fundamentals; get away from market risk now.

Sjoblom: You actually own common stock, as well.

Gaffney: I do. That's been another great way to capture good company fundamentals without taking on duration risk in the portfolio, and you’re getting paid for it. Dividend yields are very attractive when you compare them with 10-year Treasuries. The average dividend yield on the stocks in the fund right now is just under 3%. That's a nice level of income, with potential to grow, and in some ways allows me to get exposure to the areas of the U.S. that are recovering that you can't capture in the bond market because valuations are tight.

Sjoblom: So you mentioned interest-rate risk and looking to avoid it. You are hearing some different views out there in the bond market that we might be in a lower-for-longer interest-rate environment. What are your thoughts?

Gaffney: With the economic data, at least recently, looking like it's slowing a bit that does make it seem [the bond market] is going to be lower for longer, which means there is going to continue to be a very strong demand for yield, and you should see spreads continue to tighten. That's great in the short term. I do think that we've got to be positioned for that potential rise in interest rates. I’m 100% sure that at some point rates are going to rise, and that's where you find the good values today, in those type of securities that will do well in a rising-rate environment.

Sjoblom: You also have the ability to invest globally. Can we talk a bit about maybe some of the risks that you're seeing globally?

Gaffney: The U.S. seems to be leading the developed world out of the financial crisis and into recovery. The emerging markets have benefited from the demand for yield, and also that perception that because they're growing faster, they’re bit of a safe haven. We’ve seen a lot of supply, particularly in Asia, on the corporate side, both dollar pay, and more recently a lot of local pay. That is attracting yield-hungry investors, and I think it's a sign that whenever you see a tremendous amount of issuance, just pause and think "What's going on here?"

There is potential, with Japan jumping on the quantitative easing bandwagon, for inflation to take hold; not near term, but percolating away. And that’s going to pose problems for some of these developing countries that need to have a handle on their monetary and fiscal policies, particularly in the face of rising wage growth, transitioning to more consumption, and managing inflation.

Sjoblom: What would you say to investors who are already in the Eaton Vance Bond, or those who are thinking about investing in the bond fund? How should they set their expectations going forward to own it successfully?

Gaffney: A multisector strategy is a great allocation for fixed income. In a lower-for-longer environment, where you’re looking to pick up some yield and income, manage for total returns, so look to build a great long-term record. A when we get to that rising-rate environment, fixed-income investors are going to want to look a lot different than they have historically, that being broadly flexible and more opportunistic is a great way to generate some excess returns. Right now with my size, I’m very nimble and looking for great opportunities.

Sjoblom: Well, thank you very much, Kathleen, for joining us. It was good to hear your thoughts.

Gaffney: Thanks, Miriam.

Bob Johnson: Great to be here.

Stipp: You have six reasons you say why you are not the most optimistic guy on the street. The first one has to do with government spending and that it will be a headwind for us. It has been and will continue to be. What's your take on that?

Johnson: Yes. The government represents about 20% of gross domestic product. So it's not a small number, and I have been whining endlessly about Europe having difficulty getting out of the recession because there government is about 40% of their economy. The more they cut government, the more they cut their own GDP and the more they get in that vicious downward cycle. We are lucky here that government is a smaller percentage of the economy at about 20%. Nevertheless, it is hurting the economy; it has since 2010. And unfortunately the news for the year ahead is not good between the sequestration, winding down Iraq, winding down Afghanistan, wonderful things politically but not such good things dollars-and-cents-wise for the economy. Those things will continue to weigh as well as post office issues and various pension issues.

Stipp: So more pain from government coming up. Number two, the auto industry, which has been an important part of the recovery, you say is kind of peaking out at this point as far as auto sales.

Johnson: I hope I get proven wrong on this one. I very well could be because I am just looking at numbers here. But we're at 15.4 million where most of the forecasts center, that's unit per year in autos for 2013. And a typical recovery sees a peak somewhere in the 16 million to 18 million level in terms of cars. We are darn close to that right now. It's been a huge engine of growth in this recovery. We've gone from 9 million to 16 million, but now if we go from 16 million to 17 million, it's like not a big deal. It's not going to be a big help to the economy.

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Stipp: Number three: It's kind of two sides of the same coin. So we are seeing some lower food prices, but when that happens you also see some less investment, for example, in the farming industry.

Johnson: I think food prices have been coming down for some time now, and they got an extra kick in the pants, if you will, last Friday when government crop reports came out indicated that the inventories were a little bit bigger than they thought. Production was a little better in South America, and the forecast for farm prices was probably downward, which affects farm income. That means less spending on farm equipment, and it means farm land is worth less money probably than it previously was. So those are not good things for the economy.

Stipp: The fourth one involves China. We are probably still going to see growth from China, but it will be a different kind of growth and that could be a headwind.

Johnson: There's still even a lot of debate within our own firm about exactly how strong China is, and there is even a camp that says that might be a little bit soft. But even if they do return to growth, I think a lot of it will be more consumption-oriented growth. It's not going to be the copper, the lumber, the steel that has driven their export-driven economy. It's going to be more consumer-oriented goods. And it's not going to cause this big commodities boom, and it's not going to cause a rampant demand for Caterpillar equipment and so forth. So, it's going to hold back some of those things that benefited the last time China boomed, if we even grant that they are coming back.

Stipp: Number five is an important one for the U.S. economy, and that's the consumer. The consumer reports have been on a bit of a yo-yo, and market watchers have been excited and then depressed and excited and depressed about where the consumer is. Most recently they were excited because the last retail sales report was better-than-expectations. But you say the consumer is actually hobbling a little bit right now.

Johnson: Given gasoline prices, given some of the weather and rebuilding issues with all the floods and hurricanes and so forth, it really has made some of the consumer numbers jump around a lot. But when you look at them year-over-year and average them, the trend is pretty clearly down. Again, you have to expect it with the payroll tax and so forth, but we've gone from roughly 3% year-over-year inflation-adjusted retail sales growth down to 1.7%, a pretty meaningful decline, and frankly roughly in line with what the payroll tax increase might suggest. So I think that certainly caused a little bit of a headwind.

We've had some weird things happen in the numbers, where we had a really great February and a totally disastrous March, and then everybody expected yet another disaster this month [in April], and then it wasn't a disaster. You look at the data averaged year over year, and it still shows that slightly slowing trend. And the International Council of Shopping Centers data, as well, are a little bit back in the dumper again. This latest week we’re down to about 1% year-over-year growth again, which is pretty disappointing.

Stipp: So certainly some softness that you are seeing in the consumer when you take a broader perspective.

Number six, Bob, is an area of the economy that has seemed pretty optimistic and pretty powerful, which is the housing recovery. But you say you should moderate some of your expectations for housing because of a certain couple of issues.

Bob: We've already seen that in some of the numbers. I had said pretty much  we're going to have over 1 million new housing starts this year with the real hope that we'd really get to 1.1 million. We’ve kind of gotten to the middle of the year here, and it looks like we haven't had one month [with an annualized rate of more than] 1 million yet, so it's going to mean we had to be at 1.2 million by the end of the year to get to what I thought might be normal expectations.

There's been a shortage of land to build on. People don't want to live on the far-out locations, and when you get into near-in locations, there's no land available. Lumber prices have gone up dramatically. Banks have remained tight in their lending, and consequently the housing starts and the assorted construction workers that go with that are not doing as well as we hoped. The silver lining is, housing prices have gone up more, and that's really helped the wealth effect for consumers, and that's why the stock market is up and why consumer spending has done well even in light of relatively poor income growth.

Stipp: So some things will be holding back the housing recovery really for the intermediate term, But you say--and you mentioned that the wealth effect is one positive--there are a few other things. Although we might want to moderate our expectations for the economy, there are some bright spots.

Johnson: Absolutely. I think inflation has been under very, very good control. I think, when all is said and done, somewhere in the middle of the year we'll probably get inflation down to a 1.5% year-over-year growth rate. That's really dramatic. We really haven't seen that for a long, long time, and that's all in. That isn’t leaving out gasoline and food. I mean, all in, we're at 1.5%. So that means, even if income isn't growing very fast, that money is going further than it used to, and we’re probably going to end up with two or three months in a row here where the month-to-month change in prices is actually going to be down. We're going to be three months of deflation.

Stipp: All right, Bob. Thanks for giving us some perspective on some of the economic issues and maybe some good reasons to moderate some overly optimistic expectations for the economy. Thanks for joining me today.

Johnson: Great to be here.

Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.

Komal Sri-Kumar: Good to be with you, Jeremy.

Glaser: So let's start in the United States and talk about the Fed. They've recently indicated that they might have some more flexibility in terms of their mortgage-backed security buying. They might increase it or decrease it based on economic indicators. Do you think this is a sign that we're going to see even more Fed action or there's going to be a pullback soon, or is this just more of trying to get the markets thinking that's going to happen, but that the Fed is really going to stick with their current plan?

Sri-Kumar: Good timely question, Jeremy. I think we have a very dovish Fed chaired by Ben Bernanke. And while they've been giving messages including over the weekend that they could increase or decrease the amount of bond purchases, I think the move is likely to be one-way at least for the foreseeable future, namely, they either keep up their current $85 billion per month, or even increase it if they don't get economic recovery of a sufficient magnitude out of it. I don't see them going down. The reason for that, it is as if you've had a drug addict for the last four years and you've been increasing the amount of drug and suddenly you say, do you want to reduce it, do you want to go through the risk of how the patient might react? And it's the same thing with the economy. The economy seems to be growing at a very miniscule rate. Provided the QE is on, why would you want to tamper it? That's not my view, but that I think is where the Fed is coming from.

Glaser: The Fed, obviously, isn't the only central bank that's in expansionary mode right now. The Bank of Japan has announced some new plans for the last couple of months for a very aggressive expansion of the monetary base. What do you think Japan is trying to do there, and what do you think about that program?

Sri-Kumar: I think that are two separate issues. I think the Japanese have been trying now for over 20 years to get an economic recovery since the stock market collapsed in early 1990, and they don't have it. So this is their latest effort, but Jeremy, the Japanese issue is much more troubling to me. Let's see why. Japan's GDP is about one third that of the United States, roughly, and Japan is buying about $80 billion worth of bonds, Bank of Japan, every month, roughly similar to the Fed's $85 billion worth every month.

And for a country which has a debt/GDP ratio of 230%, in Japan's case, and a much smaller economy, it is really troubling that they would go to the extent of increasing money supply. Why? The risk is that there might be a flight from the Japan government bonds; the 10-year yields were as low as 38 basis points in early April. They've surged to over 70 basis points a month and a half later. They've more than doubled. What happens if it goes to 1.5%, 2.0%? The Japanese government might think it indicates economic recovery, but equally it might be a flight from Japan. So it's a very fine line that the Japanese are really going across right now.

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Glaser: What's happening with the yen there? Obviously, it's been falling in respect to the dollar. Would you see the Fed trying to weaken the dollar some more, getting to kind of a currency war to keep exports looking attractive?

Sri-Kumar: Yes, I think there is a currency war on, and I think the Japanese are playing it. Even though, over the weekend the European Union and the G-7 leaders indicated that there was no currency war and that Japan's quantitative easing is OK, in reality, Jeremy, in the last two or three days, even Australia and New Zealand have had to fight appreciating currencies by lowering interest rates. So I think overall, the Japanese are going to continue with what they're doing. There is going to be more of a retaliation, and globally we don't fully know where it's going to end.

Glaser: So what's the impact of that? What's the potential worst-case scenario of these currency wars?

Sri-Kumar: The worst-case scenario is what we had in the 1930s. That is when you had what were known as beggar-thy-neighbor policies. The countries were all depreciating with respect to each other. We have something similar going on today. The G-7 countries have told us that if you're doing it for domestic economic reasons, it is OK to depreciate. Am I going to tell you anything different? I'm also always going to tell you it's for domestic purposes. But, obviously, it has significant external implications. Japanese corporations are big exporters, and their earnings are doubling and tripling as a result of the latest policy. Clearly there is going to be a retaliation, and the worst case is that those kinds of efforts eventually cause a global recession, much more severe than if you did not have the currency war.

Glaser: Is that something that you think is likely, or is it just an outside chance that these policies could lead to that global recession?

Sri-Kumar: I think it is more than an outside chance. I'm not yet ready to say it is likely, but the probability is rising because you have Japan, which has no end in sight, and they are going to keep doing it. And I think Japan is not going to get an economic recovery out of it. That's why I'm worried. If you don't get a recovery and you keep repeating it, eventually it is going to have a negative impact globally. So I'm going to say, the probability is something like 40% that you have a real, serious global issue coming out of Japan.

Glaser: So how do we exit from these very expansionary policies then? If we have Japan in expansionary mode, and the Federal Reserve and other central banks [also implementing policies], what's the way out of it? How do they begin to wind this policy down?

Sri-Kumar: It is time now to think about an exit, but exits are always very difficult because it means going the other way and whatever kept the market going up, you have to think in terms of cutting back and hurting the market. So the exit is going to be very difficult. I think the exit will give rise to a recession, whether it is in the United States or in Japan. The reason for the recession is that bond yields are going to rise quite significantly when the exit takes place. We are all aware that when Lehman went bankrupt, in September 2008, the Fed's balance sheet was about $800 billion. Today, it's 4 times as much at $3.2 trillion. So when you're going to cut back from that and exit, let's say from a $4 trillion level at the end of 2013, the markets know that the Fed has an enormous store of bonds with it. Therefore, bond yields rise in anticipation of that, and there is a significant risk of any economic recovery being aborted by the expected increase in yields.

Glaser: So you've mentioned some of the risks of these programs. Do you see any potential benefits? Do you think that any of these programs will be effective?

Sri-Kumar: I have maintained for the last four years that you will not get an economic recovery off of monetary easing because monetary theory tells us that at extremely low interest rates, further increases in money supply or decreases in interest rates do no good in terms of helping with the real economy. So I don't think it's going to be beneficial. What the governments have to do are structural changes in Japan's case, since we have talked about it, Jeremy. The new prime minister decided recently that firing of workers is not going to be made any easier because it's politically difficult to implement a firing policy. That's a structural change. You need to be able to fire workers more easily so that younger Japanese workers can get the job, rather than people thinking of their positions as a lifetime occupation. Second, the population in Japan is aging. They need a change in the immigration laws to allow for younger immigrants to come in and settle down in Japan. Those are the types of things which are going to give Japan economic growth. It's not going to be money supply.

In the U.S., we are talking about decreasing entitlements, increasing the retirement age, and reducing Social Security benefits. Those are all necessary if we are to make the structural changes and labor market adjustments to create jobs in the U.S. Again, a QE4 or QE-infinity is not going to achieve it.

Glaser: You mentioned earlier that the exit could increase the bond yields fairly rapidly. What does that mean for bond investors? How should they be thinking about that from a portfolio standpoint?

Sri-Kumar: I think bond investors should be thinking both in the short term and in the medium term. Short term I define as one year or less. I think U.S. bond yields are headed lower. I think the speculative bubble is going to get bigger. The 10-year Treasury yield I see going toward the 1.50% mark, which would still be a significant return coming from Treasuries.

Longer term, inflation picks up in my thinking. There is going to be a pickup in the economic growth. Then at that time, the stock markets start also to experience it. But yields rise, and the presence of so many bonds in the Fed hands makes the bond yields go up much higher. So in the short term, the bond investors benefit. Medium term, they take a significant hit.

Glaser: Sri, thanks so much for your thoughts today.

Sri-Kumar: Thank you for having me, Jeremy. Good to be here.

Glaser: For Morningstar, I'm Jeremy Glaser.

Michael Rawson: Thanks for having me Christine.

Benz: Mike, let’s take this category by category, starting with domestic equity. We had a really strong start to the year. A lot of people were saying it’s the beginning of this great rotation where we will see investors embracing equity funds, but domestic-equity-fund flows weren’t all that great during April?

Rawson: No, they were kind of disappointing, particularly if you back out passive flows. So, passive flows have continued to be strong; there have been pretty persistent strong flows into passive index-based products. Flows to active equity actually were negative last month. So it was a little bit disappointing. Certainly we had to back away from that great rotation story of flows going into active equity managers because like I said, if you take away the flows to passive products, equity flows were actually negative.

Benz: International equity was somewhat a brighter story, pretty robust flows there. What kinds of products are investors buying?

Rawson: Sure, well interestingly enough, they are still buying passive products when they go internationally, as well. Particularly Vanguard Total International Stock Market had very strong flows last month. I think there is some more willingness to invest in Europe, so these core stock funds, of course, because Europe is such a large economy, they will dominate most broadly diversified stock funds. So there are some flows going back into Europe and emerging markets continues to be very strong. And so not only are investors choosing passive products, they are also tilting toward dividend-paying funds and value-type funds. So Matthews Asia Dividend Fund had strong flows last month.

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Benz: So that’s an active product. That’s one glimmer of hope for the active managers, but they have been kind of few and far between it sounds like.

Rawson: Yes.

Benz: Let’s take a look at fixed income. Mike, you noted that flows there were fairly robust, but people aren’t necessarily choosing the big core funds that they were last year. They are buying some of the more specialized products. Let’s talk about some of the categories that have been the biggest asset gatherers in fixed income.

Rawson: Sure, so it’s really been bank loan. Bank loan, nontraditional bond, multisector bond, and world bond have been the categories which have attracted more flows. Flows into the core bond, the intermediate-term bond category, which were really strong last year, they are still positive, but they are a lot lower than what they were. But it's bank loan that’s really been dominating. Bank-loan funds are up about 3% so far this year where the core bond fund is about flat, maybe up 1%. The thinking with the bank-loan fund is that you are taking credit risk and you are also taking less interest-rate risk. So if interest rates were to rise, bank-loan funds potentially could hold up better. So they have been very attractive because in theory they should perform very well.

Benz: It is a pretty small category, but it has seen great big flows. I would like to look a little bit at nontraditional bond. That’s a category that is relatively new for us, and I know it’s kind of a grab bag of different strategies, but what's sort of the unifying theme among those nontraditional bond funds?

Rawson: Well, I think PIMCO Unconstrained Bond is a fund that comes to mind. That was one of the top-flowing funds last month. There is a fund where, as the name implies, is unconstrained in terms of the duration bets it can make. So you are giving more discretions to the manager to make selections in terms of where he feels interest rates are going to go and how he can position himself defensively. Of course, a bond index fund is just going to buy everything that’s in the index. You're not going to have any kind of defense in this in terms of a response to a change in interest rates.

Benz: Mike you did some interesting work where you looked at some of the core-type bond funds that have been getting flows. You think a lot of that is actually coming from target-date flows.

Rawson: Absolutely. So, Vanguard fund of funds; their Target Retirement Series are very popular. Any kind of target risk or target-date fund is going to get a pretty consistent flows month in and month out. Now those portfolio managers, every time they have an inflow of money they have to deploy that, put that to work, and they are going to try to get the allocations back to their target. Well, with the equity market up about 12% this year and the bond market about flat, those managers are allocating more money to the bond side to bring that side back up equal to the equity side.

So a lot of the money that’s going into, I think, core bond funds is coming from the target retirement series type of funds, target-date funds, target-risk funds. So I think if you back out the money that’s coming into core bond funds from this group of funds, the flows to core bond funds looks even worse. So there, again, it shows that when people are making an active choice, putting money directly into a fund, they are tending to pick the bank loan, the nontraditional type of bond categories, whereas it might be their target retirement series or target-date funds are going into the core bond funds.

Benz: I think there have been a lot of people watching the flows into bond funds and saying, "There go those dumb fund investors again." Maybe it's really just that investors like the target-date products and aren’t specifically picking the bond funds.

Rawson: Yeah, that’s a good point.

Benz: Mike, let’s take a look at exchange-traded fund flows and where we have seen money going over the past month for the year to date.

Rawson: Sure. So last month there was about $37 billion flow into open-end funds; about $8 billion went into ETFs. So in total it's about $46 billion. On the ETFs side, two of the ETFs which are real popular last month and really year to date is the iShares MSCI Japan and WisdomTree Japan Hedged. Of course, we know Bank of Japan announced quantitative easing. Japan's stock market's up about 20% or so for the year. It’s been a great run, so it’s particularly helped these two ETFs gain a lot of assets.

Also on the ETF side a theme that has been really strong is this lower minimum volatility. So we have this PowerShares S&P 500 Low Volatility ETF and iShares USA Minimum Volatility. Low-volatility stocks historically have performed better on a risk-adjusted basis than the broad market. And particularly now it’s a very easy story to tell to clients and say, "Hey look, these stocks are less volatile. You are going to get a smoother ride." So they have been particularly attractive in this environment where we have just come out of a period of strong volatility.

Benz: And I guess it's a question for you, Mike, is it a gimmick--because if someone is looking back on the past 10 years, you saw a couple of big bear markets during that time or at least the tail-end of one and certainly another big one in 2007 through 2009--are people being kind of sold a product that is fighting the last war?

Rawson: Well, I don’t think the low-volatility phenomenon is in itself a gimmick. The idea that now is the right time to buy it, certainly it’s an earlier sale if I'm selling to someone where I'm pitching this product because you can say, "We just came out of this massively volatile environment. Look how much better you would have done in a low volatility product."

Low volatility has some overlap with high-dividend-paying stocks--utilities, consumer staples--these are segments of the market which are extremely popular and have gained a lot of assets, and the valuations have started to look more expensive, relative to the more cyclical, more speculative equity sectors, which no one wants to buy those now because we've just come out of this period of high volatility.

Benz: Let’s take a quick look at where the money has been flowing out of? Precious metals would be one spot.

Rawson: Sure, gold. So gold was down about 8% in April. It was obviously a terrible month for gold. You would expect a lot of stability in gold. But I think part of what’s happening is that the inflation numbers just have been very benign, so I think some money is coming out of gold, thinking that maybe the quantitative easing in the U.S. is not having this rampant hyperinflation type of effect on the U.S. dollar. So SPDR Gold Trust had pretty large flows last month, outflows of about $7 billion or $8 billion.

Benz: And then quickly in terms of fund families that have been seeing the biggest asset-gathering operations, you’ve mentioned a couple of them, Vanguard and PIMCO.

Rawson: Yeah, Vanguard and PIMCO continue to attract more assets than their market share. So they are gaining market share. You have American Funds continuing to lose market share and T. Rowe Price, as well.

Benz: Mike, thank you so much for being here to share your insights.

Rawson: Thank you, Christine.

Benz: Thanks for watching. I am Christine Benz for Morningstar.com.

Harry Merriken: We appreciate the opportunity to be here.

Guziec: So talking about Gateway Fund. It's a hedged equity fund that’s tax-efficient. Can you walk me through the value proposition of the hedge? And then maybe we’ll talk a little bit about the tax efficiency.

Guziec: Sure. What we feel Gateway is, and Gateway Fund has been around for about 35 years, is that our investors are investors who want exposure to the equity markets, but are concerned about the risk involved in owning equities. In particular, over the last 35 years we’ve seen a number of bear markets, particularly since the turn of the century. So what we try to do at Gateway is give people the opportunity to have equity exposure, but to mitigate the downside and limit that volatility. We do that with a two-pronged hedging program. The first part of the program is specifically designed to limit volatility. We're looking at the total return of equities historically in the neighborhood of 10%, the majority of that return comes from capital gains. The rest, obviously, is from dividends. Dividends are somewhat stable, somewhat predictable; nothing guaranteed, of course. So most of the volatility of owning equities comes from the capital gain or price fluctuation. 

So at Gateway we do something very simple. We simply sell off the upside on our stock portfolio. We own a stock portfolio that replicates the return of the S&P, and we sell off the upside in return for an option premium that we receive.

Guziec: So instead of the uncertain gains, you’re smoothing it all out with a certain payment today?

Merriken: Exactly. Once we sell that call, we know how much premium we have to earn, and the return is going to be equal to that amount of premium, and since we sold off the upside, it's the amount of premium less any depreciation in the stocks. Now, we can stand a certain amount of depreciation because we have the option premium as an offset. But if we get a significant sell-off in that stock portfolio, we want to be protected so that we mitigate the downside, and we, using our moderate return or income strategy, were able to make back that loss. So we take a portion of the option premium from the calls--and this is where the second prong of the approach comes into play--and we buy out-of-the-money put options.

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Guziec: So that protects you against your catastrophic events…

Merriken: Exactly.

Guziec: Terrible market conditions.

Merriken: The cataclysm, the market cataclysm. To be honest with you, we’ve seen potentially a couple of those start to unfold, but in many cases government intervention or some sort of monetary intervention has prevented an extreme meltdown of the markets.

Guziec: But having those puts in place even for temporary losses is comforting for a lot of people.

Merriken: Absolutely. It allows them to stay the course, as I said, to remain invested in equities, and what we believe is that the key to successful investing is to remain invested. That's what we’re trying to allow people to do.

Guziec: There is a unique spin on the fund, as well, in that it’s tax-efficient. Most alternative investment strategies are highly tax-inefficient.

Merriken: Right.

Guziec: Could you talk a little bit about how that works and how that's valuable to what type of client?

Merriken: Certainly, for our taxable clients, the tax situation with mutual funds is that mutual funds are required to distribute gains at the end of each year, and because we use index options to hedge our portfolio--index options are marked to market at the end of year--and any gains that you've realized from your options must be paid out to shareholders, unless they can be offset against losses inside the fund. Since our underlying portfolio is a portfolio of actual stocks, and stocks tend to have unrealized gains or losses, we would have a realized gain where we’d be distributing out against the unrealized loss. So the clients would actually be paying taxes on hedging benefits, reduction in losses. So what we do is actually realize the losses in some of the stocks, enough of the stocks to offset the gains, and thereby avoid having to pay the capital gain. We've done that now since 2000.

Guziec: And how do you do that? If you are using the S&P 500, being 500 stocks, index options, but then you're selling some of them to realize losses, how do you manage that portfolio?

Merriken: We actually create an optimized portfolio that will correlate to the S&P but is not the S&P. So if we have to sell 25 names to realize losses, we can do that and replace them with another 25 stocks. And the actual universe that we use to create that portfolio is potentially all listed, traded stocks. So our universe, we have a universe of about 4,000 names that have adequate liquidity for us to own in the fund because of the size. If we have to sell 25, we simply reduce the universe by 25 names and create a new optimized portfolio from the remainder for that 30-day period to meet the wash-sale requirement.

Guziec: What kind of clients most value this tax efficiency? What do you hear from your clients?

Merriken: Yes, definitely the high-net-worth clients. The many mutual funds that don't practice this tax efficiency, I think, rely on the clients having losses in other parts of their portfolio and offset it. But what we have found in the past is that clients really do value the tax efficiency and have led us to adopt this course of action.

Guziec: Great. Well, a unique product. Thank you talking to us.

Merriken: You bet.

Guziec: I’m Phil Guziec. Thanks for watching.

The decision about when to file for Social Security benefits is a complicated one, and it gets even more complex when two spouses are involved. 

Joining me to discuss this topic is Andrew Salata. He is a public affairs specialist with the Social Security Administration.

Andrew, thank you so much for being here. 

Andrew Salata: Thank you for inviting me. I know when it comes to couples filing, we have a lot of questions about what would work out best or what we're even eligible for, so hopefully this will allow a little bit more information to go out there, so we can be better informed when we're ready for that retirement decision.

Benz: Right. So the first question is, if I'm a person who has been working and have my own earnings history and I'm also married, how do I decide whether my own earnings history and my own personal benefit is better than my spousal benefit? How can I get my arms around that question? 

Salata: Well, two factors will come into play: whether you are before your full retirement age or if you are at or past your full retirement age will almost make the decision for you. If you are prior to full retirement age, you automatically receive the higher of the two benefits, whether it's your own retirement or that spousal amount. So you don't get to choose one or the other. With early retirement, you are restricted to the higher of the two.

Benz: OK. So the spousal benefit, that full retirement age is a big swing factor there. So if I am of full retirement age and I take a spousal benefit, let's talk about what I get in that case or if I file early, what my benefit is at that point?

Salata: At full retirement age, you'd be eligible as a spouse for 50% of the worker's record or you can receive your own Social Security benefits at a 100%. But one of the key things is, when you hear a 50% or a 100%, you're probably thinking, well, the 100% is a lot more advantageous. 

Benz: Right.

Salata: But there are some considerations in play where you may be able to take that spousal benefit at 50%, so you will receive some Social Security benefits, while you wait for delayed credits to go onto your record. Because if you delay your retirement, for every year you delay receipt of retirement benefits, you get 8% extra added on and you can delay up to age 70. So for our full retirement age workers now who are turning 66, that's four years, or 32% extra. 

Normally if you're delaying for retirement benefits, you're not receiving a Social Security benefit, but fortunately if you are a spouse, you'd be eligible to take at least 50% of the spousal benefit and receive some money while you're letting your own benefit accrue. So that way as we live longer into our retirement, we will have a higher amount set for our financial future.

Benz: OK. Also in the mix is when one partner in a couple is eligible for a pension and receiving pension benefits. Let's talk about the implications for the person's own benefit as well as spousal benefits. 

Salata: When someone receives a pension, as long as it's from a job where they paid into Social Security, it doesn't impact the receipt of a spousal benefit.

But for those workers that paid into a different retirement system, instead of Social Security, like city or state or any government jobs, they had not paid into Social Security. So [there is no comparison] for a spousal benefit. 

What we do is, we have the Government Pension Offset provision, and what that does is it makes a Social Security offset amount, where we look at two-thirds of the pension you receive from that work, and we offset what you can get as a spouse or even a survivor benefit, which we will talk about. So, if that two-thirds amount of that pension is higher than what you can get from Social Security, we wouldn't be able to pay you anything, or if it's lower than whatever the difference is, we pay out. So there is a factor with pensions when you don't pay into Social Security.

Benz: So even if I've worked my whole career in the public sector, and my spouse has been in the private sector, I may not be eligible for my regular spousal benefit because of that pension that I've been paying into. 

Salata: Correct, because as I talked about earlier, with Social Security, we pay one benefit. It's usually the higher of the two benefits. So if you always worked in a public sector, you wouldn't have a Social Security benefit for us to compare to. So to level the playing field, we use two-thirds of that pension since it was in lieu of Social Security benefits, to set up that comparison.

Benz: So there are obviously many different wrinkles going on here, but I'd like to talk about what happens in case of divorce. The spousal benefit is still in effect, correct? 

Salata: Correct. If you had a marriage that lasted at least 10 years prior to divorce--so we just look at the date of marriage and then date of finalization, if there was a 10-year span--you're eligible as a divorced spouse on record even if your ex- had remarried or even remarried several times. … As long as you had a 10-year marriage, you would be eligible as a spouse.

One key distinction is when you're currently married, to receive spousal benefits, your other half would have had to file for Social Security benefits and receiving Social Security benefits for you to get spousal. With divorced spouse benefits, we don't have that requirement. As long as the divorce was at least two years ago or longer, you're eligible to file for divorced-spouse benefits without waiting for your ex-spouse to file for their own benefits. 

Benz: Another consideration is for surviving spouses. If one spouse has predeceased them, what are the implications in terms of the survivor benefits that are available?

Salata: Well, with survivor benefits, that's where it even throws another wrinkle in because the age is a little different. With survivor benefits, you can receive a surviving spouse benefit as early as age 60 compared to spousal or retirement at 62. 

Survivor benefits also do have a reduction, so if you do take benefits at 60, you receive 71.5%. If you're at your full retirement age, you would receive the full amount of the deceased worker, your deceased spouse's benefit.

Another factor involved is if your spouse takes early retirement benefits and passes away, that reduction carries over into the survivor benefits as well. So, it's kind of important when you're planning the Social Security benefits [to remember that] early retirement just doesn't affect an individual's own benefit, but also any future survivor benefits as well. 

Benz: So, just to use a real-life example, say the first spouse to die was 75, and the younger spouse is 62. Here she would see their benefit reduced if they filed prior to reaching full retirement age?

Salata: Correct, yes. And that is one of the questions we do get is, well, my spouse was full retirement age or older and had passed away, but what we look at is the filer--so, the surviving spouse--when the surviving spouse begins taking the benefits, that's when we look at the level and compute whether it's going to be a reduced amount if they are taking it before a full retirement age, or if they're already at full retirement age, then it's just that full benefit. 

Benz: Well, thank you so much for sharing specifics on these very complicated questions. We appreciate you being here, Andrew.

Salata: Well, thank you for having me, and if you do need any more information, our Social Security website, socialsecurity.gov, does have a survivor page, which gives a little bit more information and planning tools, so that way couples can take a look and see what to expect in the future. 

Benz: OK, great. Thank you so much.

Thanks for watching. I'm Christine Benz for Morningstar.com.

We just released our biennial Global Fund Investor Experience Report, which measures the experience of fund investors in 24 countries across the globe.

Here to offer some key takeaways from that study is our director of research John Rekenthaler. John, thanks for joining me.

John Rekenthaler: Sure, Jason.

Stipp: So this study is about the experience of mutual fund investors. It's not really about the mutual fund industry. So what does that distinction mean with respect to what you asked in the study and what the goal of the study was?

Rekenthaler: It is quite different. If we wanted to study the fund industry, for example, we would include Luxembourg, which is a massive market. The Luxembourg-based funds are the funds that are available for sale throughout Europe and much of Asia. We don't have Luxembourg [in this study] because this is about fund investors. There aren't many fund investors in Luxembourg.

Similarly, [if we were studying the fund industry,] we would have Cayman Islands or Ireland, other places that are offshore residency. So we are not scoring the fund industry. This isn't a consultant's report for the fund industry to look at and figure out what it should be doing better. It's about the investor experience.

So we're looking at which people are buying funds, and that means not only that you choose different countries, as I said--you choose countries like China and India and U.S. that have large markets and many investors, rather than Luxembourg--but you look at different factors. We are not looking just at what the fund industry does that affects investors, but there are other things, as well. There are the government tax practices, the regulatory environment, even things such as sales and media. So, we even score how the media--how newspapers, the Internet, and so forth--in that country report on funds. … There are certain things that they can be doing to encourage long-term investing and encourage lower-cost investing. And in some countries they do that and they help people. Other countries less so.

So, we are looking across the board at the investor experience. It's not a fund industry scorecard. It's an investor experience scorecard.

Stipp: Wrapping up those findings, what's the objective of the study? What do you hope that the study will bring to light or what kind of change are you hoping that this study might bring about?

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Rekenthaler: We are hoping to bring to light best practices and get a discussion of best practices across the globe, again on all these aspects, and we've had this in the past. This is the third version of the study. Two years ago we had the second version, in 2011. 2010 was the first version. We realized it's a lot of work. We don't need to do it every year. We do it every two years now.

And we've had fund industries in different countries respond to this and look at this and ask questions and probe and think about what they're going. We've had a number of regulatory bodies and regulatory agencies do this. I don't think the press specifically has come to us and said, "How can we get better?" But they see how they're scored on this, and they see the factors that we are looking at. And in sales practices as well, where we look distribution systems and how funds are distributed and sold.

So in all those areas we have had what we hope to get, which is people looking at what we are doing. We are just trying to … get some attention put onto these factors, which otherwise cannot be talked about.

… This is still, to my knowledge, the only study that looks at fund investor experiences except for a couple of cost studies that the academic community has done. There was a lot done on stocks, for stock investors: So, what countries give good disclosure, what countries have good corporate governance. But not for funds. So, that's what we are trying to do.

Stipp: And you looked at four specific areas in this study and in past studies. What are the primary factors that you're grading the countries on?

Rekenthaler: We are looking at fees and expenses, clearly that's critical. Just ask Jack Bogle about that. So, we're looking at the costs of owning funds, which vary between countries.

We're looking at disclosure. So what's the sort of information that you as an investor get, and different countries have different rules and different practices for disclosure. We are actually not looking only at formal rules. If there is not a formal rule set up in a country, and it's not mandated, but funds tend to offer it anyway, we look at what happens in practice. So that's a minor distinction.

So fees, disclosure, regulatory and tax practices, basically government practices.

And finally, as I mentioned before, sales and media, so how are they sold and how are the funds talked about--four areas.

Stipp: And you are grading countries on an A to F scale. How exactly does it work? Is it some kind of a curve or is it each country on its own? What are the criteria behind the grade?

Rekenthaler: That is a question we can talk for a long time [about]. There are many questions in each of these areas. Each question is weighted differently. So some are five-point questions, some are yes or no, like one- or two-point questions. So we sum them all up. Each of the areas gets a score from A to F, depending upon how they do. The scale is set up effectively as kind of a curve. We are looking for a reasonable distribution of grades. We don't want everybody to end up at C+, or we don't want everybody to be A's or F's. So, we're scaling within each of the four areas then we combine the four together. I don't think this time we did scale it, previously we did, but there are some details as to how the grades are put together. But you can rest assured that the countries that are getting B's overall have more overall points than the ones that are getting C's and the one that got a D.

Stipp: And the four areas that you mentioned, … those grades roll up into a primary grade, and when you look at the overall grades for the countries, there were a decent number of B's and C's across the globe, so not a terrible state for investors at all.

But when you look at the high level, what are some of the biggest bright spots that you see where the investor experience is really good, and where are some of the areas where we really have some room to improve on the investor experience?

Rekenthaler: Well, I think if we can talk about bright spots, and we just step back and look at this from the big picture, there's very little mutual fund scandal in a big way globally in the sense of what happens with hedge funds. Mutual funds aren't just sort of disappearing one day, and it turned out that they were a fake entity and the company that's running the mutual fund disappears, and now that the price goes to zero.

I've tracked hedge funds over the years and followed hedge funds; there are a lot of hedge funds that go to zero in a day. It wasn't just the Madoff funds. There were many smaller funds. You don't see that in the fund industry. The fund industry has rules set up for the custodians, so that the custodian is separate from the investment company and the regulations and so forth.

So, the bright spot is--and the reason why there's no failing grade, and almost every [country] gets B's and C's--is these things do run the way that they say they're going to run, and for the financial services industry, they are remarkably scandal-free and clean.

So, areas that they can improve? Well, they certainly could become cheaper. The U.S. does well in this. We'll talk about that, but many countries have funds that are a lot more expensive than in the U.S., and while scale is a part of the reason why--because they're larger--it's also cultural. There are other things they can do to lower their costs. So, costs are a big issue.

And disclosure is also a practice that varies widely across the globe. There are countries where you can't even get the portfolio holdings, you are not even permitted to know what it is that your fund invests in. So those are areas that [could be improved]--making the investment process less opaque.

Stipp: And you mentioned the U.S. How did we, here at home, how did we score? What grade did we get?

Rekenthaler: The U.S. has its highest score of A, as it has had three years in a row, which we have been accused at times of being a U.S.-based firm, so that's why those results occur. And … I'm willing to accept some of that, that there's some U.S. viewpoint that comes through in how the questions are framed.

On the other hand, no matter how you look at it, the U.S. has the lowest-cost funds across the globe. And the U.S. has the most disclosure and best disclosure across the globe. [However,] we don't actually lead in portfolio holdings, disclosing once a quarter as a requirement and once a month for many funds, with a lag. There are actually some countries that do better.

But many other details--who the portfolio manager is--that is still information that's inconsistently given across the globe, but an absolute standard here [in the U.S.]. And when the portfolio manager started and how the portfolio manager was compensated, the compensation structure, and how much money does the portfolio manager, or do the portfolio managers, have in the fund--that sort of information. And those are our two biggest [categories]--there's 60% of the score between fees and disclosure. And the U.S. is just a runaway winner in those two areas.

Stipp: So, fees and disclosure were scoring very well. Overall, we got an A. But one area we didn't do as well is in regulation and taxation. The U.S. got a C there. What caused that score to be a C? What didn't we do better? What factors would need to be present for that grade to be a B or an A?

Rekenthaler: Well, two big things are; one, the U.S. has multiple regulators. There is the NASD [now FINRA], a self-regulatory agency watching over fund advertising. There is the SEC. There are state regulators. In our view and our experience, … it's better to have a single regulator rather than have things fall between the cracks or having two or three regulators all looking at an aspect and it's more costly and just more of a hassle to the organization to … deal with multiple regulators. So sometimes you're dealing with two or three regulators--sometimes zero. And in our view, one would be the better number. So, multiple regulators: It would be nice if we cleaned up that front.

And the other area is on taxation. … One thing we do is, we take a hypothetical investment of $100,000 over a five-year period, and we run it through a tax model, and see how much people would pay in taxes. It's the same investment in 24 countries with the same results. And what's the tax bill? The U.S. has among the very highest tax bills.

Most countries do not do what the U.S. does, just for one example, where every year a fund is required to pay out capital gains on the realized capital gains in the portfolio. In most cases [across the world], you pay capital gains on a fund when you sell the fund--if you pay capital gains at all (there are certain countries where you wouldn't pay capital gains). You don't get hit with a capital gains tax bill if you're just holding the fund and not making a trade yourself. So, our tax policies are not particularly favorable to fund investors.

Also something worth pointing out, … this is meant just solely from the perspective of the fund investor. It's not a political document. We're not trying to say what best tax policies are for countries worldwide. We're saying that from the perspective of a fund investor, paying fewer taxes, less in taxes, is better. It's just that simple. And from that perspective, the U.S. has not scored well, and a lot of the Asian countries in contrast tend to score very well.

Stipp: John, some really interesting insights from a very important study. Thanks for joining us today and giving us the key takeaways.

Rekenthaler: Thank you, Jason, and it's 150-page report or so, so we've got 149 more to discuss.

Stipp: Well, that report is available on morningstar.com. All of our readers can check it out and get all the details there. Thanks again for joining me.

For Morningstar, I'm Jason Stipp. Thanks for watching.

Justin, thank you for joining me today.

Justin Demko: Thank you, Andy.

Gogerty: So, as I said in the intro, this space is growing. Education among advisors and RIAs is really out there, especially in the independent broker-dealer space. But there is a parallel shift going on inside the wirehouses where FAs and private wealth teams such as yourselves are also looking at these strategies as opposed to the historical or traditional investments. What's kind of driving that shift inside the wirehouses looking at ETF managed portfolios?

Demko: I think if you look at the history of what solutions the advisors have had to offer their clients and the model in which we've used in over the last, say, 15 years or so primarily using managed accounts and mutual funds, a number of advisors have looked to have a solution that focuses more on expanding out the number of options that they have to bring to their clients. So, with ETFs and our team, we use that as a core offering within the equity side, whereas we will use from a satellite standpoint managers and mutual finds around that core of ETF portfolios.

Gogerty: What about in terms of being inside a wirehouse, you essentially have two options. You could build it yourself or you could tap into a "home office" or like centrally provided ETF strategy. What goes into making that decision for a team inside a wirehouse such as yourself?

Demko: The good thing about being at the wirehouse is you have a lot of intellectual capital at the firm brought to the table. So, what I've seen there is a lot of advisors have used the models that are created primarily from the ground up through, for example, UBS, through the UBS wealth management research department. And an example of that would be a high-dividend strategy where the research department is doing the research on the single-issue stocks and then that's being fed up to a trading platform that the advisors can then use to implement across their portfolios.

Gogerty: What goes into going out and talking to these financial advisors? Obviously, your team has decided to go the latter route and build your own ETF strategy rather than tap into a prepackaged solution.

Demko: Right.

Gogerty: What went into that process in not only making that decision, but then deciding to take it to not only your direct clients, but other financial advisors inside your wirehouse network?

Demko: So, for us, when we made the shift from primarily using separate account managers on the equity side to using an ETF portfolio, we still use the research coming out of UBS that helps guide us for the asset-allocation decisions. That's the primary starting point for our asset allocation. Once we have the asset-allocation in place, we then use a covered-call option overlay on top of that which is proprietary to us.

In terms of the advisors using our strategy, they have, of course, the option at UBS to go a number of different routes. What we've shown over the last five years through skillfully managing the portfolio on the ETF side and on the option side with an alpha of about 6.85% annualized over last five years is, we found that advisors like to be able to tap into another team that has experience with private clients where they can then use our strategy or be partners with us to then bring to their client base or also use it as a tool to go out and acquire new clients.

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Gogerty: You had mentioned options as part of your strategy, which is something that even ETF managed portfolio strategies outside the wirehouses are using to some degree from time to time. What is the main goal of the options overlay in your strategies? Are you looking at tail risk or kind of that unknown or known-unknown, or are you using it to generate income and dampen volatility? What's kind of the primary goal of your strategies in using the options?

Demko: We started off in 2007 designing the strategy and then implementing in 2008. Now, as you know, there has been a lot of volatility over that time period.

Gogerty: A little.

Demko: Having a covered-call strategy has been very helpful in generating income into the portfolio.

Gogerty: OK.

Demko: So, primarily what we do is, through the selling of 30-day covered-call options we generate income on a monthly basis, and then that income is then either distributed out to clients who need cash flow or it's reinvested. And through compounding, we end up buying more shares of the underlying ETFs in the strategy which ultimately over time results in higher returns as the market moves up over a longer period of time.

Gogerty: Basic reinvestment, compounding dividends is kind of how historically people have done with their mutual fund distributions typically.

Demko: Correct, exactly, additional share repurchasing. When we look at the strategy, we like to look at it as a pyramid. So, in order to get to that top of the pyramid where you're hoping for alpha or outperformance, the base of that pyramid is asset-allocation first, and then a look at dividends, and then consistent rebalancing, and then finally that option overlay that creates the additional income into the portfolio which for us has led to our alpha.

Gogerty: There is a tactical component. Now, while you're not wide-ranging where you'll go all the way to cash or gold, all the way to dividend-paying emerging-markets small caps from month to month, there still is a tactical component to your strategy, where you are looking to position it as the best relative opportunity for your clients. What are some of the changes either in and out of the portfolio, say, over the last three to six months that you've made? What's the flavor of the portfolio now? What are you looking at from either an asset-allocation or an investment opportunity perspective?

Demko: I am glad you asked that question. From a tactical standpoint, we follow the firms' modeling in terms of what they are putting out from an asset allocation standpoint, which they publish on a monthly basis. Part of what has led to our success and our outperformance is the fact that we haven't made large moves within the portfolio. So, if you look at our allocation now, even from the inception going back five years, you won't see a drastic move in or out of any asset classes to a large degree. It's more fine tuning. If you've seen an asset class run up over time, you're going to start paring that down. Consequently, if you've seen an asset class sell off over a period of time, we might take that up 2% or 3% in terms of the allocation.

Gogerty: In addition to your tactical or kind of a hybrid model where you have a strategic model and you're rebalancing it, volatility is obviously a key component in option investing. What has that volatility done to the option overlay over the last say three to six months or even over the last year?

Demko: Recently the VIX has been quite low relative to what we've seen over the five years that we've been running the portfolio. What we've found though is as long as you stick with the discipline of writing out of the money calls on each individual asset class that we manage, you end up still producing meaningful income. Now granted the income in 2012 and 2013 is very different than the income we were receiving in 2008 and 2009, but the difference is, is with the low volatility what else are we seeing? We're seeing an increase in the underlying equity market, right? So, we're still making it up on the appreciation side of the underlying ETFs.

Gogerty: So, it's still a total-return focus at the end of the day, not really just separating the portfolio just for income or just for capital appreciation. The components are actually working together and can be complementary.

Demko: That's exactly right. What we've found is that if you maintain the consistency of selling out-of-the-money covered-call options on these individual asset classes, over time you're going to create that small amount of income. But through the compounding effect, it's going to turn into a meaningful outperformance given the fact that in some markets, if you're writing those calls too close to the money, you're going to miss out on the appreciation. So, you're absolutely right. Total return is really the focus at the end of the day.

Gogerty: Great. Justin, thank you for your perspective and your time today.

Demko: Thank you very much.

Gogerty: This has been Andrew Gogerty talking with Justin Demko from UBS Private Wealth Management. For more information on ETF managed portfolios, please visit out ETF managed portfolio center on Morningstaradvisor.com. Thank you.

Sarah, thanks for joining me.

Sarah Bush: Thanks very much. I'm happy to be here.

Glaser: We’re still in the midst of an incredible bull run for fixed-income investors over really the entire history of this conference, but now that yields are so incredibly low with the 10-year Treasury rate below 2%, are there any opportunities left? What kind of challenges do investors face right now?

Bush: That's a very interesting question. I actually went back and looked and was trying to guess how high the 10-year Treasury was when we started doing these conferences. If you look back 25 years, the 10-year Treasury was actually a little bit above 8%. So, that's a very different environment. I covered Dan Fuss at Loomis Sayles, and he says that in his early career, all you had to do was get long and stay long, and that was the secret to success. So, we are at a very different place.

So, we actually have our main general session panel on bonds. We have three very experienced fixed-income investors, who will be helping us think about that question, and certainly one of the approaches people have taken is to look beyond the traditional investment-grade U.S.-focused bond market.

So, we are going to be joined by Tad Rivelle at TCW. We will also be joined by Curtis Mewbourne at PIMCO, and Steve Smith at Brandywine Funds, and each one of those firms has taken a slightly different approach. So, one thing that we can certainly look at and we'll talk a lot about is what opportunities are there in the global fixed-income markets. So, we're looking at developed markets and developing markets, and obviously, with everything that's happened with the European credit crisis, we're thinking a little bit differently about risk in that arena. So, we'll certainly touch on that.

Another question that comes up for a lot of investors is what kind of a role should currency play in their bond portfolios. Is it too volatile? What should they be looking at? What kind of risk controls are in place? And this is something we certainly are seeing more bond managers make more use of, so that's something we'll certainly be thinking about.

And then a third area is obviously just looking at a broader opportunity set even within the U.S., and TCW has obviously been very active in the nonagency mortgage market. So, that's an area we can expect to hear some thoughts on.

And then finally, this will be an opportunity to ask these very experienced investors the big question. How long do they expect interest rates to stay low, and at what point should investors be thinking about repositioning their portfolios?

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Glaser: That's kind of on the interest-rate-risk side. What about credit risk? We've heard a lot of investor interest in things like bank loans, and other high-yield funds. What do you expect to hear about credit risk?

Bush: We certainly have seen that interest. I think we saw something like $24 billion in closed high yield last year, and bank loans are seeing something like $15 billion just through the first quarter of 2013. So, that’s really an area where there is a lot of interest. And I think what we have been hearing from managers, and we'll certainly talk about this at the conference, is that fundamentals remain strong and yields are still attractive relative to Treasuries. But you are in an environment with very low absolute yields. So, what kind of risks are out there, and how are managers thinking about that?

I will actually be working on a panel that's going to talk specifically about corporate bonds, both investment-grade and high-yield. So, we’ll have some representatives from Western Asset, Ryan Brist will be with us, and they are a very big player in the investment-grade arena; Gibson Smith from Janus, who manages high-yield and investment-grade portfolios, will also be with us. We will also have high-yield manager from BlackRock. So we will able to talk about that whole spectrum and how are they thinking about risk in their portfolios and where there are opportunities.

One place where a lot of investors were talking about opportunities coming out of 2011 was in the financials sector in corporate bonds, and we'll certainly be asking some questions about this. Is that opportunity still there, and if not, where are they finding good deals?

Glaser: You mentioned that even in high yield, the absolute levels of yield remain pretty low, which is sending investors looking for income elsewhere, be it dividend-paying stocks or in alternative-type products. Do you think those are reasonable alternatives to fixed income? How do you think about those other income-seeking investments?

Bush: I think that's one of the challenges, just to think about what kind of role bonds are playing in your portfolio. If you're looking for something that's providing diversification from the equity markets, you have to be careful about investments that are going to be fairly correlated with the equity markets. Again, we'll have some other panels at the conference to help investors think about other ways to think about income.

So, we have Morningstar's Josh Charlson, who is going to be looking at multiasset approaches to yield, and also we have Morningstar's Mike Taggart, who is going to be heading [a session on] getting income out of your closed-end portfolios, which is another approach.

I also would encourage people to look into [Morningstar director of personal finance] Christine Benz's work. I think, she has done some very interesting work on thinking about how to blend a total-return and an income approach when thinking about your portfolio and your income needs, and she will also be hosting a panel on retirement income.

Glaser: Sarah, I’m looking forward to those. Thanks for joining me.

Bush: Great. It was great to be here. Thank you.

Glaser: For Morningstar, I'm Jeremy Glaser.

Shannon Zimmerman: Good to be with you, Christine.

Benz: Shannon, let’s discuss some of the best-performing categories year to date.

Zimmerman: So far year to date, and this through the end of April, what you see among the diversified domestic-equity categories here at Morningstar, value has trumped growth and larger has trumped smaller. But not to a fund. There certainly are some outliers, and we’ll talk about a couple of those in a minute. But so far anyway, if the pattern persists, it looks like this is going to be a good year for value.

Benz: But, nonetheless, strong performance really across the board.

Zimmerman: Absolutely.

Benz: So even though you’ve been better off in value and maybe large caps versus small, even if you had a small-growth fund, you're still looking at positive returns for the year to date.

Zimmerman: Everyone's a winner.

Benz: So, in terms of the value categories that have performed best, is it large value at the top of the heap?

Zimmerman: Large and mid, they're sort of close by. [There have been] double-digit returns so far on the year for those.

Benz: So what do you think is driving that trend?

Zimmerman: So a couple of things. I think that on the one hand, you hear it from a lot of pundits and some fairly talented money managers who’ve been at this for quite a while that the market does look pretty fully valued. This is a lengthy bull run. In some ways, it’s approaching the time that people are going to start calling it a historic bull run.

Benz: Four years really with some bumps along the way.

Zimmerman: Exactly. I think that for a lot of investors, and for lot of analysts, frankly, it doesn’t feel that way because we’re still sort of shell-shocked from 2008. So, while we fell so far, surely we’re going to need some time to get back to where we should have been if it hadn’t happened. But still by historic standards, this is a lengthy bull run. So a lot of folks, pundits and talented money managers, are saying the market looks pretty fully valued. So that may be one way of explaining why value has trumped growth so far this year.

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Benz: So in that environment people are looking to some of those companies they perceive to be cheaper.

Zimmerman: Exactly right. Those are the more fertile areas of the market to find opportunities that don't look so overpriced. The other thing, and you and I were talking about this a little bit before this segment started, the dividend bubble: Is there one, or is there not one? We’re going to be talking about that at the upcoming Morningstar Investment Conference. But the higher yields on the value side relative to growth may be driving that, as well because investors have been sending money into dividend-paying securities for quite some time now.

Benz: Let’s look at some of the growth categories because even if you happen to have a certain growth fund, you haven’t necessarily underperformed. There are, in fact, some growth funds that have done really well.

Zimmerman: Sure. I wanted to talk about two of those. One is Vanguard Capital Opportunity, which just recently reopened after being closed for over nine years. And it's run by the team at Primecap, a very talented group of money managers. They run a number of funds, all of them are quite strong. This one was closed for nine years. It’s open now. It has about $9 billion in assets, so it’s not a small fund by any stretch of the imagination. But our analyst who covers it for the fund research group, David Kathman, says it’s one of the best growth funds out there, and I tend to agree. David has given the fund a Gold Analyst Rating, and I think that that’s certainly warranted.

Benz: There are funds available directly through Primecap, Primecap Odyssey Aggressive Growth and a couple of other ones. Why would I look at that Vanguard fund versus the other Primecap funds that have been open and are, in fact, small than this Vanguard fund that just reopened?

Zimmerman: Maybe it's in your 401(k); that is one reason. You should note, too, that Vanguard is keeping it closed to all channels except the brokerage platform. But it’s a good question. Primecap runs a number of funds. Like I say, all of them are quite strong, and they’re smaller. But even at $9 billion for a large-growth fund, that's not a huge amount of money. It has about 125 stocks in the portfolio, so it’s pretty diversified in terms of numbers of names, as well. And maybe you’re just a Vanguard investor. I mean, certainly the expense ratio is very attractive at this fund. I think it’s about 48 basis points relative to a large-growth average of about 130 basis points. So it’s attractively priced, run by a very talented team, and maybe you have all your money under the roof at Vanguard and you want to keep it there.

Benz: Another fund you wanted to talk about, Shannon, this is a ClearBridge fund. It’s a broker-sold fund, an advisor-sold fund.

Zimmerman: That’s right.

Benz: Let’s talk about how it has kind of also bucked this trend toward growth underperforming. It's actually done very, very well year to date.

Zimmerman: That’s right. So both of these funds, they’re in the large-growth category, which as we were saying earlier, has not been the hot spot in terms of relative performance. These are two of the top-performing funds so far year to date. This is ClearBridge Aggressive Growth. It’s been run since its inception in 1981 by Richie Freeman, and it is accurately named. It is an aggressive-growth fund. ClearBridge is actually an affiliate of Legg Mason. For the most part, they’re fairly buttoned-down. They err on the side of caution. They really want to make sure that they don’t blow investors up. But this fund is quite aggressive. It has a 10% position in its top name, which is Biogen Idec, and most of the assets are really stuffed into the top holdings. Courage of your convictions is a cliche, but in this case it really does hold because Richie Freeman and his co-manager, Evan Bauman, really do have a lot of confidence in the names that they have put into the portfolio and have had in the portfolio for years, decades. The typical turnover rate is less than 10% at this fund and that has been a boon, of course, for the fund’s tax efficiency in addition to having terrific trailing returns just in terms of total returns. The aftertax performance of the fund has been strong, too.

Benz: Any time I see a fund with a manager with a 30-plus-year track record, I start wondering about succession strategy and will this manager decide to hang it up. What's your take on that particular situation for this fund?

Zimmerman: Well, it’s an excellent question. I have to say that I interview the team there probably twice a year, I guess. Richie Freeman, who is the lead manager, shows no signs of wanting to retire. He loves managing money, and he loves baseball. But Evan Bauman had served as an analyst on the fund for many years prior to becoming a named comanager. We haven’t really talked about succession per se because again really there’s no hint that that’s even in the offing for Richie Freeman. But I would imagine that Evan Bauman would be the one to take over the fund, should Richie Freeman decide to retire.

Benz: Last question for you Shannon. We’ve had  relatively strong gains or strong gains in absolute terms, certainly, for stock funds really across the board so far in 2013. So I think at times like this investors start buzzing about whether it's time to maybe sell in May and go away, pocket what you’ve managed to earn, and maybe hunker down and cash for a while. What's your take on that question, and what do the data show about that sort of strategy?

Zimmerman: My take on it, to use a technical term, is it’s goofy. Any kind of arbitrary investment decision that isn't based on an assessment of the fundamentals of your holdings in your portfolio or maybe it's some embrace of mean reversion--you’re going to trade out of the parts of your portfolio that have done the best and are going to trade into maybe the parts that haven't done so well, on the theory that mean reversion will work its magic and over time the parts of the portfolio that were down will have further upside--if it’s based on that, then that makes sense. And you're exactly right; we have been on a really nice bull run, as you were saying, for years now. And so people may be of the view that, "You know what, the market looks more than fully valued to me, and I want to reduce my equity exposure."

Benz: So see if rebalancing is in order right now?

Zimmerman: It could be. That will be a sensible decision. To just arbitrarily, mechanically say, "All right, well, it’s May. Time to sell my stock portfolio and get back at some later date." That doesn't make a lot of sense to me, and the data certainly in recent years do not bear that out. In fact, May has been in the top half of the monthly returns for the S&P 500 for the last 35 years. So it's not a bad month. The back half of the year may be a little slower, but beginning with May through the end of the year in December, every month has a positive average return over the last 30 years, except for September, which is marginally off.

Benz: Well, thank you so much for providing that perspective, Shannon. Thanks for being here.

Zimmerman: Glad to be with you. Sure.

Benz: Thanks for watching. I’m Christine Benz for Morningstar.com.