Principal Capital Management, although already overweight corporates compared to the Lehman Brothers aggregate, is selectively buying bonds with new money rolling in.Lisa Stange, portfolio manager in Des Moines, Iowa, said there is room for additional spread tightening, and notes that, overall, the performance of the corporate sector has been very good and should continue that way as corporate profits improve.
Principal has been buying into sectors such as utilities and financial institutions that should benefit first hand from the Federal Reserve's easing policy, as they are the first ones to see the positive impact of lower interest rates. For instance, the firm owns and continues to buy Calpine Corp 8.625% of '10 (Ba1/BB+). Strange likes the California utility's management style and adds that, in addition, its spreads have continued to widen, leading to potential tightening in the future. Principal also recently purchased Countrywide Home Loan 6.85% of '04 (A3/A) at 137 basis points over the two-year treasury. It was trading at 127 basis points off the curve last Monday.
Stange says that her entire portfolio, with a 6.21% option adjusted yield, has outperformed its benchmark by half a percentage point. While the Lehman index has a 26% weighting to corporates, Principal allocates 49%, and Stange believes that this "double overweight" is beneficial with corporate spreads tightening by 38 basis points so far this year. She says spreads will possibly come in more as the lower interest rates begin to have a positive impact on the economy and corporate profits. She adds that once the easing cycle is completely over and the market starts to anticipate a slowdown in prepayments, MBS--which are slightly underweight--may become relatively attractive again. At that point, Stange may consider buying into more MBS.
Stange manages a $4 billion portfolio whose asset allocation is 49% corporates, 34% MBS, 10% treasuries, 4% CMBS and 3% ABS. With a 4.80-year duration, the fund is barely longer than its benchmark, the Lehman Brothers aggregate, whose duration is 4.72 years.
