Kevin Dachille, portfolio manager at Mercantile Capital Advisors, will swap 5% of the firm's portfolio or $7 million, from mortgage-backed securities into corporates when the yield curve begins to flatten. The trigger for the move will be when the spread between the two-year Treasury and the 30-year long bond tightens to 50 basis points. Last Monday, the spread stood at 300. The flattening indicate speeds which is not a favorable environment for MBS performance, he says. In this flatter yield curve context corporates should outperform MBS.
Dachille says he will liquidate current coupon 30-year MBS, as those are more susceptible to prepayment risk than their 15-year counterparts. He will look at Ginnie Mae's, Fannie Mae's or Freddie Mac's. With the proceeds, he will invest in corporate bonds in the utilities and finance sectors. He declined to name specific bonds but says he likes those sectors because they have been hurt by headline risk and that the wider spreads do not necessarily reflect the credit's intrinsic value.
Dachille manages a $140 million total return bond fund out of Baltimore. He allocates 42% to MBS, 40% to corporates, 12% to agencies and 6% to Treasuries. At 3.30-year, the fund's duration is short its benchmark, the Lehman Brothers aggregate index, which has a 3.90-year duration.
