Cavanaugh Capital Management will buy some $50 million in mortgage-backed securities. Jim Dugan, portfolio manager of $700 million in taxable fixed-income, says that with interest rates a bit higher than their lows, and perhaps climbing as geopolitical risk subsides, he sees prepayment risks diminishing. Cavanuagh will buy shorter-maturity securities that have lower extension risk than conventional 30-year pass throughs. These include 15-year Ginnie Mae midgets, balloon mortgages with a final maturity of five- to seven-years and certain Planned Amortization Class (PAC) bonds that are structured to limit extension risk. Dugan says Cavanaugh is in the market now making the purchases, and hopes to have the program complete within three weeks.
To raise money for the purchases, Cavanaugh will use a combination of cash, Treasuries and corporates. The trade will be duration neutral, he says. The firm will sell corporate credits in sectors such as banking and consumer goods that are trading very tight to Treasuries versus other credits.
Recent corporate sales include the Merrill Lynch 6% notes of '05, which were sold at 59 basis points over comparable Treasuries, and the Procter & Gamble 6.60% notes of '04 at 30 basis points over the curve. Dugan sees nothing wrong with either credit, but says they trade at such a high price relative to their historical average and the rest of the market that selling them makes sense. Going forward, Cavanaugh may look to unload bonds from Wells Fargo.
At a duration of 3.7 years the core product of the Baltimore, Md., money manager is slightly short its bogey, the 3.85-year Lehman Brothers aggregate index. It allocates 32% to taxable municipals, 26% to MBS, 16% to agency debentures, 14% to corporates, 8% to Treasuries and 4% to cash.
