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[music] consuelo mack: this week on wealthtrack, maverickbond investor stephen smith studies countries and currencies around the world to find bondsworth investing in. what's he collecting now for his top performing brandywine global opportunitiesbond fund? a wealthtrack exclusive with great investor stephen smith is next on consuelomack wealthtrack. sponsor: new york life along with mainstaysfamily of mutual funds, offers investment and retirement solutions so you can help yourclients "keep good going." sponsor: additional funding provided by:loomis-sayles - investors seeking the exceptional opportunities globally.the wintergreen fund - your home for global

value. hello and welcome to this edition of wealthtrack,i'm consuelo mack. how worried are you about the bonds in your portfolio? if you have beenlistening to many of our wealthtrack guests, you are probably very concerned. several ofour recent great investor guests have called the bond market extremely dangerous and risky.after a thirty plus year bull market in bonds, they see little upside and plenty of downsidepotential. of course they are mostly referring to the u.s. bond market, u.s. treasury securitiesin particular, which have already seen signs of weakness. but this week's guest has a different approach.he runs a top performing global bond fund

and he says there are plenty of opportunitiesin the fixed income world, especially outside of the u.s.he is stephen smith, long time lead co-portfolio manager of the five star rated brandywineglobal opportunities bond fund, which has delivered stock market like returns over theyears as exemplified by its performance over the last three and five year periods and sinceinception. as smith points out, the advantages of going global have been and are enormous.if you thought u.s. treasuries have had a good run over the last ten years with theirnearly 5% annualized total return, consider australia's 12% returns, or canada's 9.7%,or poland's 9% or sweden's nearly 8% performance. it turns out among nearly 20 government orsovereign debt markets, the u.s. was toward

the back of the performance pack. another benefit of going global? the improvingcredit quality among developing markets. twenty years ago, only 2% of emerging market sovereigndebt was rated investment grade- that means with bond ratings of triple-b or higher- fromthe ratings agencies. the rest were not. fast forward to now: 60% of emerging market governmentdebt is rated investment grade. only 40% is not. bonds of chile, china, malaysia and polandrival those of the u.s. and other developed markets. so where is stephen smith findingvalue in global bond markets now? he says it all begins with the story of the market.i asked him why that is so important for him to understand as an investor.

stephen smith: well, i think it's really importantthat you have some kind of a context or framework for your strategy. and in the last numberof years, you could have written a book about this year of living dangerously. you couldhave written it after lehman brothers, you could have written it in 2009, '10, '11, '12.and i'm not just saying that tongue in cheek but we've had, you know, the greece, greecewent bankrupt; you have the european malaise. you had a nuclear meltdown in the third largesteconomy in the world, in japan. you had to deal with the sequestration. so how do you,actually, as an individual, take all this in and... you know, it would almost be exhausting. consuelo mack: right.

stephen smith: and so what we did is, firstof all, when you just look at the environment, i didn't know-- probably like most other people--after, which i thought was the worst policy error in 80 years, lehman brothers, leavingthem go, if we were going to have a depression or not. and so what you needed is a frameworkto say, okay, we are not. and what happened is the third week in february of 2009, bernankehad this expression of will, he put a stake in the ground and he said, "i'm going to guaranteeall the bank commercial paper, cds, and any corporation that wants to issue commercialpaper, we'll guarantee it for three years." now, the bears may have taken that and theymay still be bearish, but you could say that was a tremendous expression of will, and ijust say look in the rearview mirror, the

rest is history. and so with that we had afinancial crisis. and the financial crisis was twofold. one, we had a misallocation ofresources to the real estate sector. consuelo mack: right, all those housing loans. stephen smith: and then secondly, we had amisallocation of resources to big government. and so the way you get out of the real estatecrisis is you don't build more houses, and the way you get out of a crisis of big government,is you don't actually increase taxes. and so when you just go look at that context,one of the issues you had is very simply this: what was the real estate crisis? and thisis extremely important. in 2008 the gdp was approximately, you know $12 and three-quartertrillion, and we lost $8.5 trillion in wealth.

and the average consumer was wed ... had alot of his wealth wed to real estate. consuelo mack: right. these areas, this is...these are paper losses. stephen smith: these are paper losses. stephen smith: and 28% of homeowners wereunderwater on their mortgages. so bernanke studied the recession, the depression of the1920s, and this was the framework. bernanke could not afford to have the banks or theus citizens continue to have deflation. and so he just set on a path, and his goal washe wanted asset prices up. now, you can sit and argue about qe1, qe2, qe3, we may haveqe6- but at the end of the day, was he successful? and you just look at it from 2006 'til today,we've had two and three-quarter percent inflation.

and if you just go look at the storyline,the stock market, after that enormous hit, is now up over 125%, and now you've got realestate prices up, year over year, almost 11%. so we would argue that what he needed to dowas establish collateral, because if you can establish the collateral, you then createconfidence. so to me, i think bernanke has been extraordinarily successful. consuelo mack: so the story, when you lookback at the financial crisis on how everyone was really panicking, and even at brandywineglobal, i'm not saying you were panicking, but the opportunities fund had a rough year,right, in 2008? stephen smith: right.

consuelo mack: so... but you didn't... didyou recognize the story then, in fact, that there was a, you know, that bernanke had puta stake in the ground and that, in fact, that that was an essential part of the turn aroundand, therefore, we will invest accordingly? stephen smith: what we did with bernanke,had that expression of will, and you had corporate bonds yielding four or 500 basis points morethan treasuries, you had the australian dollar, a lot of the commodity currencies were down30%. we felt it was time that the information risk versus a price risk were wrong. and whatbernanke wanted was he wanted asset prices up, and he was going to do whatever it takes. now the interesting thing to me is, as thisthing moved forward, you then ended up in

a crisis in europe. and so what we've beenthinking about all along is leadership, that leadership matters. and so he provided theguiding light. consuelo mack: right. so what's the storynow, as far as the story of the market? and i know that a key question, and you just mentionedit was, you know, you're saying your key theme is, was ben bernanke successful? what if benbernanke is, in fact, successful? stephen smith: right. and it's hard to havejust one leader, but luckily draghi. consuelo mack: mario draghi, right. stephen smith: he graduated ahead of bernanke,mit, sort of out of the same cloth, really understands markets, understands what we need.so then we had another leadership position.

and then, lo and behold, we actually havea politician showing leadership. this abe decided to get out of 20 years of deflation. consuelo mack: right, prime minister of japan. stephen smith: and you can see, does it makea difference? i would say yes. and so a year ago, we started to ask the question, whathappens if ben bernanke is successful? consuelo mack: and being successful meanswhat? stephen smith: well, being successful meanswe have a self-sustaining economic advance. consuelo mack: okay. without very much inflation? consuelo mack: lower unemployment right.

stephen smith: right. so a self-sustainingeconomic advance means that the government can withdraw its stimulus, the economy createsenough jobs and the unemployment rate continues to fall, you don't have much inflation, andpeople develop a sense of confidence that we're not going to have a recession becausei would argue all along, because of economic policies, that this is about confidence. andso we just keep thinking, well if bernanke is successful, where is the misallocationof capital? and so when we look at the world, we would say u.s. treasuries, german bondsand gilts, which are supposedly the store value- and for people who don't know, giltsare british bonds- that those are the bonds which people think are safe havens that wethink have the most risk.

consuelo mack: so that's a misallocation ofcapital, for people to be investing in those government bonds in the u.s., the u.k. andgermany. that's the wrong place to be at this point. consuelo mack: if bernanke is successful,if in fact the economy recovers. okay. stephen smith: now you have to think aboutwhy are people doing it? well, if you actually, if you experienced 2008, and the market wentdown, what's been happening- which i find is absolutely fascinating and i try to talkto financial advisors about this- when i go and you look at the... since the recoverybegan in june of 2009, you go ask a panel of people who are investment people, and anywherebetween 25% and 37% of them say in the next

year there's going to be another tail riskevent. and basically what that means is another lehman brothers or another depression. consuelo mack: right, and this is supposedto happen once every 80 years, but they're saying now in the next year-- and these areprofessionals, right? stephen smith: these are professionals. sopeople are all worried about risk. and so they have the, you know, rich people say,"i don't want to lose my money." they see the state pension funds have 42% of theirmoney in bonds because they're just worried about risk. and so the question really onthe table is that if you've been spending the last five years worrying about risk, whathappens if bernanke is successful? and so

you just have to think, in other words, it'snot like reading the headlines today. consuelo mack: so what are the headlines goingto be in six to nine months? stephen smith: well, i think what's goingto happen is unemployment rate is going to continue to fall, housing prices are goingto continue to go up, the equity market is going to be okay, and just like in the lastyear, there has been, u.s. treasuries, last summer, had a double, in my opinion, a doubletop in prices, yields fell one basis point below where they were on december 18th, 2008,and interest rates are up in the treasury market by over 50 basis points. i would askyou this: does the world come to an end? no. is the equity market up? yes. are real estateprices up? yes. and actually, even the question,

is the consumer actually going into debt andborrowing? he's still not doing that. and so things are getting better. what's happeningin the corporate sector may change its mind, individuals may change their mind for riskappetite. and then that would just mean that bernanke is going to have less and less of,you know, he's going to have less and less conviction about buying $85 billion worthof treasuries or agency paper, you know, every month. consuelo mack: so the story really is fundamentallychanging, so we've gone from a risk averse market to a, to one that is basically rewardingrisk taking, and you think that's going to continue. so, therefore, how do you investin an environment like that as a bond investor?

stephen smith: okay. well, as a bond investor,a couple of years ago, one of the reasons we've been very fortunate is we had a lotof like long bonds, duration was, you know, over eighty years. in other words we had abond portfolio with, you know, 20 year average maturity or more. and now we've cut that durationin half. and the reason we've done it is because of this worry about success. to me it's likethe natural order of things. if bernanke is successful, would anybody in the listeningaudience be surprised if t bills went from zero to one percent? i don't think so. notif the employment rate is coming down, the housing market is doing well and, you know,you are actually creating jobs. now, the reason we have a better shot at this is if you thinkabout, when i mentioned about a politician

abe, he finally said enough is enough, it'sthe third largest economy in the world, they want to have growth. stephen smith: and so at the margin that'sgoing to make a difference. you think about europe. europe has been in a recession. andeven somebody in kindergarten would have known why did they go into recession? when you thinkabout 2011, trichet was chairman of the central bank, and what was he doing? consuelo mack: tightening. stephen smith: tightening. raising interestrates. what's that do? slow the economy down. secondarily, when berlusconi was in office,out of office, and they finally threw him

out, they brought a technocrat in. now, wehave studied this historically, it's just that the press, and most people don't believethis, but if you cut government spending-- we did the re-sorts on canada in '95, swedenin '93, spain in '77, there was nine instances of this after world war ii- there's no correctivemethod, but generally speaking it should be $9 in government spending cuts to $1 in taxincreases. so not only did they raise rates, but what italy did is they did $8 in tax increasesto $2 in spending cuts. consuelo mack: so, therefore, you knew, infact, that europe would be in a recession and it would for a fairly long time? stephen smith: what would you expect? absolutely.and the fascinating thing-- and that's why

this business is an art-- is that when youraise interest rates they lead with a lag, which basically means that when you raiseinterest rates it's going to affect the economy with a long lag. and so what happened is draghihad to put up with the after effects of his poor policy. but now we're at the point where,as an investor, you can say europe is-- last summer was very, very, very bad. and now itmight just be very bad. and maybe a couple of weeks, months from now, it might just bebad. but when you move from very bad to bad, less bad is actually good, and that's whythe equity markets have been going up, that's why interest rates have been coming down.and when you just think of the word trust, it's really important. draghi hasn't evendone anything except he did the same thing

that bernanke is. last summer he had an expressionof will and he put a stake in the ground, he said the euro is here to stay. stephen smith: and the rest, again, is history.and i would argue the bears have been fighting it. i could sit here and give you a greatbearish story, but i just look at it. we have now come to the point, is that central banks,they're big, they're powerful and they can move markets. consuelo mack: so if the story of the marketsnow is that risk is going to pay, that economies are coming back, that things are improving,what do you do as a bond investor? and bring the global, your... the aspect of your globalinvestor into this as well, how important

being able to invest globally is too? stephen smith: well this is extraordinarilyimportant. but you have to understand i have a bias because i've been doing this most ofmy life. and the reason global is so important is that every country is in a different pointin the business cycle; like the u.s. has been struggling to grow, whereas you do have somecountries like turkey, russia, mexico, and even the last year, this country, some ofthem been growing four, four and a half, five percent. and so they are at a different pointin their business cycle relative to where the u.s. is. and the reason this is importantis that if you just look at a country like you would a corporation.

consuelo mack: so your largest weightings,basically, are in mexico? stephen smith: mexico is our largest weight. consuelo mack: and so why is that? why mexico? stephen smith: well if you think back, saysix months ago, i could have the choice of buying a bond here with a two percent handlefor 30 years, or i could buy a bond in mexico with seven percent. and you think, well, isthat a risky investment? their inflation rate and our inflation rate are exactly the same.their debt as a percent of gdp is around 41%. ours is 82... a little over 80% and the presidentdoesn't feel that we have a spending problem. not only that we have a big trade deficit.they're basically running a very, very marginal

trade surplus. and their economy the lasttwo years has been growing between three and a half and four and a half percent. they hada change in the political party there and so, there's again, leadership matters. they'redoing a lot of supply side things that i think are going to invigorate the economy. so iwould just ask somebody, why would you not want to own a mexican bond with yields twoand a half more times than a u.s. treasury? consuelo mack: because of the political risk.because of, you know, what you... they're still an impoverished company, because ofthe drug cartels and the drug wars. all of those things, they matter too, so how do youfigure that into the equation? stephen smith: there is no question underthe calderon administration there was 58,000

people, you know, killed in the drug cartel. consuelo mack: yes, right. stephen smith: and it's in a very, you know,they're in areas that are away from where the manufacturing sector are. consuelo mack: so the economy was not affected? stephen smith: so the economy is not beingaffected by it. and so you just go look at it from the standpoint of their wages areabout $3.50; wages like, there like here, haven't gone up for almost a decade. they'renow competitive with china. ten percent of all the cars in the world are actually builtin mexico, so they moved up the chain. and

what's more important, consuelo, is that theirshort-term interest rates are three and three quarters percent. they actually have a yieldcurve. they, they don't, they have not had to manipulate the... they have not had tomanipulate interest rates to zero to sustain their economy. and so as a global bond investori could look at brazil, where short rates are seven percent. i can go into australiawhere short rates are two and three quarters; poland three and a half percent. so aroundthe world there are a lot of countries that haven't had the real estate crisis, haven'thad what we had. consuelo mack: so what do we do for our oneinvestment for a long-term diverse fund portfolio? what is it, the one thing with this new storyof growth, what's the one thing we should

be investing in? stephen smith: well, having done this for,i hate to say, over four decades, i had actually thought, about a year or so ago, that thenatural order of things, is all of our portfolios are long only, and not that there's anythingwrong with that. but what we've been doing is we've been becoming more and more defensive.in other words, we've been selling- almost all our corporate bonds are sold, almost allof the treasuries are sold in what i would consider the store value markets. and we havebeen reducing risk, you know, raising cash in the anticipation that the markets are goingto go up. and so a lot of people would say, well, steve,that's not going to make me a lot of money.

but sometimes it pays to play defense ratherthan just offense because it might just pay to be patient and tap your toe. and so i'vebeen telling people that, you know, as a global bond manager, maybe the thing you might wantto consider is going with a strategy where you can short bond markets or, if you feelreally vitriolic about a currency, go short circuit currencies. and you know, as a wayto, you know, make money in a world of low interest rates and, particularly, if bernankeis successful and you basically, the world gets lifted and interest rates gradually movehigher. consuelo mack: and so looking around the globeas you do, are there any countries that stand out, for instance, that are going in the oppositedirection, that actually are... where interest

rates are going to go lower? or is this prettymuch a global phenomenon where interest rates are going to start rending higher? stephen smith: no. as, as inflation fallsthere are countries, as you say, i mean you can get seven percent rates in the front endof the russian t-bills. you can get seven percent rates in turkey. you can get sevenpercent interest rates in, in brazil. consuelo mack: and these are countries thatyou've invested in government bonds of those successfully. stephen smith: and you can get seven percentinterest rates in india. so, as you, say, reduce your risk in the u.s., the questionwould be, well, gee, are these really risky

investments? and i would just pose the oppositeside of that. if i buy a one-year t bill at seven and a half percent in each of thesefour countries, if nothing happens i get seven and a half percent. if i do it in the u.s.i get ten basis points. so i could even be slightly wrong in the currencies by one ortwo percent and still get a better return than a, than a ten-year or 20-year or 30-yeartreasury. and so it's all trying to look at what are the risk adjusted returns. and youcan actually end up having a fair amount of cash, 25, 30% of your portfolio, actuallyearning a handsome rate of return over and above, you know, what the inflation rate ishere in the u.s. consuelo mack: so that would lead me to askyou for one investment for a long-term diversified

portfolio is, maybe i should be investingin some of the government bonds of the countries that you mentioned, that have, that... shortterm, their short term interest rates that have much higher yields. stephen smith: right, because they're in adifferent ... trying to get the point is, they have, they're at a different point intheir business cycle than the u.s. is, and so by holistically looking around the worldyou can capture that. i mean so what we do is the world is our oyster and so you're justlooking at, if i have a dollar to invest, do i want to put two or three pennies in india?do i want to put two or three pennies in russia? do i want to put 15 pennies down in, you know,in mexico? do i want to take all my money

out of long treasuries, which we've done along time ago, because we don't think that they have value? and so this is just the wayyou manage money. and, you know, just like i said, started this about the year of livingdangerously, i mean i don't know what's going to happen in the next six months. i know there'sgoing to be a couple of crises and they will probably create opportunities if you actuallyhave, you know, cash on the sidelines waiting to take advantage of that. and so that's,that's basically what we do for a living. and over a long period of time, it has beena very, very successful investment strategy. consuelo mack: that it has. so stephen smith,thank you so much for joining us, from brandywine global opportunities fund, it is a treat tohave you on wealth track.

stephen smith: thank you, consuelo. consuelo mack: at the conclusion of everywealthtrack, we give you one suggestion to help you build and protect your wealth overthe long term. this week's action point is: think globally in your bond portfolio. wejust heard steve smith at brandywine explain how his ability to invest in the governmentbonds of foreign countries with improving finances, economies and currencies has enabledhim to outperform the markets and competitors over the years. we should certainly be takingadvantage of those fundamentals too. among morningstar's other favorites in theworld bond category are funds run by wealthtrack guests, including michael hasenstab's templetonglobal bond fund and david rolley's loomis

sayles global bond fund. given the dominantposition that heavily indebted countries have in traditional global bond indexes, this isone area i would recommend investing in an actively managed bond mutual fund. and speaking of the same, next week we aregoing to argue the active versus passive debate with two pros who are very familiar with bothstrategies: vanguard's daniel wallick will present the active side and gerstein fisher'sgregg fisher will weigh in on passive strategies. if you would like to watch this program again,please go to our website wealthtrack.com. premium subscribers can see future programs24 hours in advance, and additional interviews with wealthtrack guests are available in ourwealthtrack extra feature. and that concludes

this edition of wealthtrack. thank you somuch for watching and make the week ahead a profitable and a productive one. value.tocqueville - contrarian investors combining independent thought with in-depth research.[music]