State Street Global Advisors will look to reduce its corporate allocation by roughly $500 million in its actively managed portfolios. Joe Marvan, who oversees $50 billion in taxable fixed-income, says volatility in the Treasury market has picked up markedly over the last six months, reflecting greater uncertainty over the outlook for the U.S. economy. As a result, State Street will shift into Treasuries and agency debentures until the firm has a clearer picture of where the economy is headed.
Marvan sees the banking sector as a particularly good candidate for profit-taking. "While they are in decent shape from a credit perspective, as the yield curve flattens, net interest margins get compressed which will be a drag on earnings," he says. He also argues that if inflation continues to drop, it will put added pressure on the banking system. Marvan noted that credit defaults swaps (CDS) on five-year Bank of America paper was trading at 25 basis points last Tuesday afternoon, just five basis points wider than five-year Fannie Mae CDS. Marvan thinks this differential is too small, given that the mortgage lender has the implicit backing of the U.S. government. Five-year CDS protection for Bank One Corp., Wachovia Corp. and Citigroup was also all within 10 basis points of Fannie Mae CDS, Marvan notes.
Telecom is another sector where State Street will likely reduce exposure. "Telecom makes me nervous. There are a lot of general competitive pressures in the industry, and there is basically no pricing power. This is still a very large capital intensive industry that will have big problems in a disinflationary environment," he says.
In its mortgage portfolio, State Street recently sold roughly $1 billion in pass through securities in a wide range of coupons and maturities. Marvan says the move was intended to reduce convexity in the firm's portfolio due to continued falling mortgage rates and a likely new wave of refinancing activity. He is also concerned that a flattening Treasury curve could be negative for MBS. Cash raised from the sale went to commercial mortgage backed securities and Treasuries.
In its actively managed portfolios, the Boston-based firm is 2-3% long one of its main bogeys, the 4.46-year Lehman Brothers aggregate index. It allocates over 30% to MBS, and 28-30% to corporates, of the remaining 40-42%, the bulk is in Treasuries, with a small allocation to agency debentures and CMBS.