Several fixed-income portfolio managers say they are slowly building their corporate bond positions. And, some of them say a U.S. invasion of Iraq will serve as a catalyst for their strategy. "We're in the process of forming a bottom. If you're underweight corporates or don't have corporates, this is a really good time to begin adding," says John Burger, portfolio manager at Merrill Lynch Investment Managers (MLIM). He cautions, however, that he expects extreme volatility over the next two months or so.
While Treasuries outperformed corporates by over 200 basis points in July, that gap narrowed to 56 basis points in August. Through September 22, Treasuries had the edge over corporates by just 16 basis points, according to data from Creditsights.
Paula Horn, head of investment-grade at Deerfield Capital, says the firm has gradually been building its corporate bond position in total rate of return portfolios over the last month and a half, but is still underweight. Deerfield will likely be overweight corporates by early fourth quarter, Horn says. However, if the expected war with Iraq goes poorly and the consumer pulls back, "all bets are off," she says.
Others expect their next move will come when an ouster of Saddam Hussein appears imminent. Burger says MLIM will move $110 million into corporate bonds after, as he expects, the U.S. engages with Iraq and wins a quick and decisive victory. The money manager will also take another $110 million out of defensive corporate credits such as consumer goods and rails, and move into lower-rated names that offer greater yield. Burger will also sell energy credits, since, as he argued last Thursday, that there was a three to eight dollar "war premium" in the price of oil. However, he continues to express concerns about earnings, corporate governance and the larger economy. If a victory over Iraq appears in hand but the job market remains weak, MLIM will likely move back into a defensive posture, Burger says.
Kathy Beyer, portfolio manager at the Investors' Management Group (IMG), believes the economy will improve unless an extended conflict drives oil over $30 a barrel for a protracted period of time. In that event, IMG would reduce corporate exposure--especially to economically sensitive issues such as airline enhanced equipment trust certificates. The firm is currently overweight corporates, but it has steered clear of a number of benchmark issuers, including Ford Motor Company. Beyer's hope is to limit IMG's downside risk, but still be in a position to benefit if the market recovers. "When things do turn, we'll see a sharp contraction in spreads in a short period of time. Yields to Treasuries are at a historic extreme, and you have to be there and be positioned for an eventual recovery," she says.
One New York-based money manager of over $15 billion in taxable fixed-income believes most buy-side accounts are currently neutral to slightly overweight corporates, and will remain so until the U.S. strikes Iraq. "Corporate governance issues, whatever remain, will no longer have much of an impact. Everyone is focused on Iraq, and no mainstream money manager is going to take any big risks with a war looming. The same is true for the economy. We're not going to have any meaningful kind of business spending until we see clear signs that we aren't going to have a drawn out conflict."