Top picks from top pros

Dan Fuss and Kathleen Gaffney
Loomis Sayles Bond (LSBRX)

How they invest: Lead managers Fuss and Gaffney, with Matthew Eagan and Elaine Stokes, take an aggressive approach to fixed income, investing up to 35% of the fund in high-yield debt and up to 20% overseas.

Where they are looking:
Dan: "The U.S. is having the sharpest turn in credit fundamentals that I've ever seen - in a positive way. But our sizable budget deficit will likely put upward pressure on interest rates. While there's less risk that companies will go out of business, there's more risk that yields will rise, which would cause bond prices to fall. So we're shortening the average maturity of the fund from 13 to 11 years. Longer-term bonds are more sensitive to interest-rate hikes."

Kathleen: "Rising interest rates would also limit the upside for many high-grade bonds. So we've cleaned out long Treasuries and we're bringing down credit quality a bit to maintain high yield. But not too much. There are some investment-grade bonds that are still a good value, and there's room for them to do well."

Their picks:
"We're buying intermediate-maturity, investment-grade corporate bonds such as Viacom and Xerox. High-yield bonds with improving fundamentals such as Ford and Hospital Corp. of America offer good value. We think down the line both are investment-grade credits, and that's not reflected in their yields. But we are avoiding riskier high-yield bonds right now. The problem for low-quality companies is that it's going to be a very slow economic recovery.

"We also have a fairly large position in foreign-government bonds, like Canada, Australia, New Zealand, and parts of Asia. They have some of the same economic and budget problems that we have to deal with, but not to the extent that we do. Our sizable budget deficit is going to put upward pressure on interest rates. But the deficits of many of these foreign countries are not quite as large, so they don't have to raise interest rates quite as steeply."

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