Banks and insurance companies are increasing their participation in the collateralized mortgage obligation market as a way to hedge extension risk amid a rising-rate environment. MetLife and Chubb Corp. are among the investors that have shown interest in long and intermediate planned amortized classes (PACs), a form of CMO. These have an average life of 7-20 years and carry a coupon of 4.5-5.5% and are seen as attractive hedges for both duration and extension risk.
Chubb plans to invest any new cash in 4-6 year PACs because of their natural hedge against duration risk, according to Paul Geyer, who manages a $4.5 billion structured portfolio. He said he has been investing in PACs for the last month.
Broker-dealers note that investor demand for CMOs has been in the region of $25-30 billion in recent weeks, considered a large amount for CMOs, as the rate picture becomes clearer and investors pour into hedging instruments. However, demand slackened a bit last week ahead of the Federal Open Market Committee meeting on Tuesday and Friday's employment report.
Gregory Slonaker, portfolio manager at MetLife, said the firm has initiated a significant increase in its CMO holdings. He declined to be more specific.
To be sure, the heightened interest makes sense, since CMOs were created as a way for investors to hedge duration risk. Customized investments are suitable for buyers who need to match their investments with their liabilities, according to John Dolan, chief investment strategist at Hyperion Capital Management.
