Peter Demirali, portfolio manager at Cumberland Advisors, will extend duration once the 10-year Treasury yield rises to a 5.25-5.75% target range. The 10-year Treasury yielded 3.59% as of last Monday. Demirali will wait for Treasury prices to drop to more "decent value" before he brings his fund's duration neutral to the benchmark. Once the 10-year Treasury yield target is hit, Demirali will proceed to extend duration by rotating 15% of the firm's $180 million portfolio of taxable municipal bonds from the two- to three-year maturities into the seven- to nine-year range.
Demirali plans on making this move during the third quarter, as he anticipates Treasuries will sell off due to a renewed risk of inflation combined with an economic recovery. He predicts an end to the current "flight-to-quality" as both monetary and fiscal policies remain highly stimulative. In addition, the continued weakening of the dollar is inflationary in nature and should contribute to drive Treasury yields upward, he says. He wants to buy into longer taxable municipal bonds in order to add duration because they offer higher yields than similarly rated corporate bonds and they tend to be safer. Demirali says triple-A rated taxable munis offer a 10-20 basis points yield pick-up over comparable corporates. He says taxable munis represent an attractive "niche" asset class.
"Municipal investors can't look at it because it is not tax-exempt; and taxable investors don't own it because it's not in their index or they don't understand it," he says.
Demirali allocates 40% to short-term floating rate debt or money market equivalent, 30% to taxable municipals, 25% to Treasuries and 5% to corporates. The firm, with a two-year duration, is currently significantly shorter than its bogey, the 5.40-year Lehman Brothers government credit index.
