Trevor, Stewart, Burton & Jacobsen will buy corporates and extend duration when rates go up. The firm most recently shortened duration and sold off its mortgage and corporate allocations, which had accounted for roughly 5% of the portfolio in favor of short, callable agencies, plain coupon Treasuries, Treasury inflation-protected securities and strips with the view that inflation has bottomed and will return, driving interest rates higher. Alan Kral, portfolio manager of $500 million in taxable fixed income in New York, said he is putting new cash into the existing 25% allocation of short callable agencies with maturities of two and a half years or less. He has also gradually shortened the duration of the fund in anticipation of higher rates. Kral noted that he is running a very "clean portfolio" with little interest rate and credit risk.
Kral doesn't see any benefit to owning corporates with expected rising interest rates and feels that the longer the Federal Reserve waits to change rates, the further he thinks they will move. He commented that the situation won't be positive for yields in general and added that he is even watching his TIPS allocation carefully, noting that implied inflation rates are sufficiently greater than reported rates and TIPS may lag due to this. "They have already performed. Whether they continue to perform is another question."
Kral will be prepared to lengthen duration as rates go up. "As the market begins to anticipate what we think is going to happen, the benefit of going short goes away." At that point, he will start to lengthen the portfolio, but still questions when that will be. For Kral, corporates would require a significant widening cycle before he invested in them again. He would be interested in double-A corporates if they widen to 100 basis points over Treasuries. They are currently around 40 to 60 over.
At just under four years, the fund's duration is at a minimum according to guidelines and is underweight its benchmark, the Lehman Brothers Aggregate Bond index which is in the high five-year range. In addition to 25% in short callable agencies, the firm invests in 35% plain coupon Treasuries, averaging three years, 25% in Strips with an average three-year duration, and 15% in TIPS, averaging seven to eight years in duration.
