Ron Ryan is the CEO and founder of Ryan ALM Inc., an asset management firm that is focuses primarily on asset/liability management. He has been developing fixed income indexes for more than 30 years. Recently, IndexUniverse.com assistant editor Heather Bell spoke with him about fixed income markets and other related topics.

Index Universe (IU): Why should investors use a bond ETF when they could just buy bonds directly?

Ron Ryan (Ryan): At the moment an ETF is an index fund, which means you know what you're getting. It has a pretty definite set of rules; it has usually a pretty long historical risk reward behavior, so you understand exactly what you're buying. As a portfolio of bonds, you certainly have portfolio diversification as well. I would think it would also save you money because to try and buy a lot of bonds as a portfolio is somewhat time-consuming and it could be somewhat costly, especially for individuals. But the idea is that you are trying to capture the risk/reward of, hopefully, an index and that's what an ETF is so good at. You have an instant portfolio.

IU: Where should investors position themselves on the yield curve today? Could you give an example of a scenario?

Ryan: Sure. A pension fund, for example, would most probably want to buy bonds that best behave like some part of their liabilities. That could be the entire yield curve or a certain part of it. Foundations and endowments maybe want to do only the short area because that tends to fit their time horizon. But apart from that, the shape of the yield curve today is very positive sloping, one of the highest, widest yield spreads in modern history, suggesting that you do get paid to extend.

If you think of a skier, they want to go find the best slope on the hill so they can slide down. It's the same thing here. Mathematically through time the maturity you buy in will become shorter, and if the shape of the yield curve stays the same, then you will invest into a rally, so to speak. The shape of the yield curve suggests that you want to extend, if you can, and it depends on your objective. But even on the short area you want to buy the longest maturity in the short area. At the moment that's what the shape of the yield curve is suggesting you should do: Take advantage of rolling down the yield curve.

IU: How much of an impact will the continuing credit crisis have on very short duration funds?

Ryan: The Fed guides short-term interest rates, and we have short-term interest rates now at very low levels. Today's yields levels are around 50 basis points away from the lowest yields in modern history. Our data goes back to the birth of the Treasury auctions on a continuous series, basically to 1973. For the two-year Treasury, for example, the lowest yield that we found was 1.073 and today it's in the neighborhood of 1.50, so we're 50 basis points away from the lowest yields of all time. That certainly plays havoc with money market funds, because after fees they struggle to show a yield or a return. You would think that would be temporary, but at the moment they certainly are doing damage to money market funds I should say. I don't know how much further they can go. They're already close to the lowest levels in modern history.

IU: Did the subprime mortgage crisis hit every aspect of the fixed income market? Did it hurt certain areas more than others?

Ryan: It certainly widens the spreads between Treasuries and corporate bonds - particularly mortgage banks. That's where the damage is done. It also has created some liquidity concerns.

Here's the thing you might want to think about: Low interest rates were sort of the cause of the mortgage problem, so how could low interest rates be the cure? That one's a real tough scenario. I don't think lowering interest rates is the cure here. It certainly hurt the mortgage area and it certainly hurts pensions - which nobody seems to talk about - because the liabilities of pensions behave like bonds.

When you lower interest rates, the present value of liabilities goes up just like for a bond. That could hurt the funded ratio, or assets versus liabilities. If the funded ratio gets hurt, then usually the pension fund has to put up more money in the form of a contribution. That's what has happened throughout America. We have a budget crisis among cities and states that have to put up a lot more money, and they don't know how they're going to do it. As a result, they are selling assets like toll ways and bridges, convention centers; they're borrowing money. They really are in a budget crunch.

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