Northern Capital Management will add exposure to adjustable-rate mortgages using the firm's cash allocation, which is 5% of the portfolio, or $17.5 million, says Greg Sweeney, portfolio manager of the Fargo, N.D.-based asset management firm. The rationale is to shorten duration from 3.50-years to 3.25-years to protect principal as rates are bound to rise and the yield curve steepens, he says, although he won't predict the timing of the rate increase. Another concern is the fact that investors are netting negative rates of return, he says, indicating that interest rates should move up this year. For instance, with the CPI at 3% and the five-year Treasury yielding 2.80%, a five-year Treasury investor loses in real rates of returns, he says.
Sweeney likes ARMs because of their short duration, relatively high coupon, liquidity features and fast reset. For instance, his ARMs funds have a duration that does not exceed one-year. Yet, at 2.80%, the fund has a yield that is the equivalent of the five-year Treasury, he says. He also likes the diversity of this fund, which is comprised of Ginnie Maes, Freddie Macs, Fannie Maes and Federal Home Loan Bank ARMs. In addition, 15% of this ARMs' portfolio resets monthly, which means that he gets a full reset in coupon rate every seven months.
Sweeney manages a $350 million portfolio. He allocates 45% to corporates, 25% to agencies, 20% to ARMs, 5% to Treasuries and 5% to cash. The fund is short its bogey, the 5.25-year Lehman Brothers government credit index.
