Mahony is a portfolio manager at J. & W. Seligman and manages $1.5 billion in investment-grade bonds from New York. He has been at the firm since 2001 and is part of a group of five portfolio managers, analysts and traders in taxable fixed income.
What factors drive your investment decisions?
There are four main factors driving our decisions in investment grade: average duration, curve exposure, sector selection and security selection. Security selection jumps to the top like in 2003 after you have an Enron and a WorldCom. We're defensively positioned from duration standpoint. Right now, even with the high [producer price index] number, those prices are not getting passed to the consumer and inflation is muted, but [higher CPI] is coming.
How are you positioned in the curve flattening environment?
We have been positioned for curve flattening and continue to be. We're overweight the 20-30-year end of the curve, mainly in corporates, agencies and Treasuries, although not much in mortgages. Except for really structured products, mortgages tend to be pretty short duration products of 10 years and less.
At the long end of the curve, we don't see inflation being a tremendous problem. One other discussion that's taking place is about how pension funds need to mark to market on a daily basis. If pension reform goes forward that's going to create a technical bid for the long end of the market, too. In the past six months the 10s/30s curve has flattened from 80 basis points to 40bps.
As the front of the curve continues to rise we've been buying floaters. As the [Federal Reserve] keeps raising rates, those coupons keep resetting at higher levels.
Where are you overweight and underweight?
In terms of sectors, we're a little bit underweight Treasuries but less so than we used to be. In agencies, we've been a little bit underweight, but we're looking to add to that position. Fannie Mae the other day showed it's shrinking its mortgage holdings. We think that is a positive from a bond standpoint because Fannie Mae is making itself more creditworthy.
Within agencies, we're looking for a bond with the right structure and the right term, rather than the names. We've been buying one-time callables: we recently bought a 10-year agency bond callable only once in the first two years. We like one-time calls because two years down the road, it should be trading tighter than an eight-year bullet. We picked up an additional one-time callable that was 76bps off because of the optionality of the call. We look at things like this when rates are higher so they won't be called.
We've been overweight mortgages since we started thinking corporates look rich. In a low-volatility environment, mortgages are a good holding because they're very high quality. We've had a fairly substantial position in mortgages. What we own is exclusively pass-throughs. We own a pretty diverse coupon stack of discounts, premiums and current coupon mortgages. Right now we have a pretty market-weighted portfolio of mostly Fannie Mae and Freddie Mac. One place we stay away from is really low coupons: 4s, 4.5s and 5s because that's where the extension risk is.
With interest rates rising, do you think agencies will cut back on issuing callable debt?
If agencies stop issuing callable debt that's all the more reason to own them now. But that's a question probably better asked of the agencies themselves. The agencies are such large and complex hedging machines they're going to issue something attractive to them for some reason and not give me 40bps because I'm a nice guy. As they shrink their books, agencies have cancelled a number of issues scheduled to be issued. So another reason we like the market is that there will be less issuance going forward.
What is your strategy in corporates with spreads as tight as they are? Have you invested in credit derivatives?
We're a little bit underweight in corporates and content to stay there. Corporates continue to grind tighter. There's obviously a lot of money chasing these things and there continues to be enormous overseas buying. From a corporate standpoint, there was explosive spread tightening from 2003, which continued through 2004 and 2005. Where we're positioned at this point in the game is a higher-quality trade--we've had a higher quality rating than the benchmark for the last nine months or so. Our benchmark is the Lehman Brothers Government/Credit Index.
Credit derivatives are not a part of the market we are involved with at the moment. To some extent we have a conservative client base that has asked us not to be in that market.
What kind of relationships do you value with salesmen?
Some of the people we talk to we've been talking to for 15 years. When we do pick up new coverage, I explain to them how we look at things and tell them what things are important to us: their macroeconomic outlook and what their trading desk is thinking. We're pretty forthright with sales coverage in what we want and don't want.