Lawrence Shaw, portfolio manager at Alliance Capital Management, is pondering protecting or reducing his portfolio's triple-B corporate exposure by 10%, or $100 million, in anticipation of greater corporate sector volatility due to the potential war with Iraq. He has not decided if he will do this via the use of credit default swaps or by rotating into Treasuries. Shaw says he will make the move this week or next based on the amount of new corporate issuance.
Shaw argues that if he decides to rotate into Treasuries, he will seek to buy in the 10- and 30-year sector. The heavier the anticipated new corporate supply in January, the more likely Shaw will be to use this option. He also says that with the political uncertainty, Treasury prices may continue to rise at even higher levels over the next month, as a flight to quality will drive investors to buy more Treasuries. Last Monday, the 10-year Treasury yield was at 3.78%.
If Shaw decides on credit default swaps, the corporate bond allocation would not change. He says he would finance the purchase of these derivatives through the interest income earned on the firm's bond portfolio. Shaw says he will be more inclined to use this option if he sees smaller than expected corporate issuance, as the likelihood of buying corporate bond backs at wider spreads would then be reduced.
Shaw manages a $1 billion corporate bond fund out of New York. He allocates 70% to triple-B corporates, 20% to high-yield bonds rated single-B or double-B and 10% to single-A or higher investment-grade corporates. With a 8.75-year duration, the fund is short its bogey, the 10.07-year Lehman Brothers long Baa credit index.
