Allied Investment Advisors, a Baltimore-based investment firm, will rotate from Treasuries into ABS when it thinks the Federal Reserve is done lowering interest rates, according to portfolio manager Wilmer Smith. Smith, who oversees $300 million of the firm's $7 billion in fixed-income assets, argues this will probably not be until the May 20 FOMC meeting, and he is anticipating an inter-meeting rate reduction. But, when the Fed is finished, he is ready to rotate 5%, or $15 million, of his short Treasury position into liquid AAA ABS credits in the HEL sector.
Smith likes the HEL-sector due to its general immunity from prepay risk. To offset the lack of liquidity, he would stay under 3.5 years or shorter average life. Bonds from issuers such as The Money Store and Equicredit are some of his prospective targets, and he would buy at par or at a slight premium, but nothing exceeding $101.
In terms of auto-loan ABS, Smith likes bonds backed by receivables from Ford Motor Company and General Motors, with maturities shorter than 1.5 years. He would also buy student loans, but with a one year or shorter term.
Smith is avoiding agency paper for several reasons, including the 80-100 basis point spread differential ABS offers over agencies. Secondly, the firm pursues a barbell credit strategy. Going down the credit curve, it selectively picks Treasuries and corporates, skipping the intermediate credit category class of assets, such as agencies (lower credit than Treasuries) and high-yield bonds (riskier than corporates.) Finally, the manager feels confident with the falling rate environment and considers the Fed's action "aggressive" enough, given the state of the economy. "If I thought the Fed wouldn't step up and wasn't on [the bondholder]'s side, I wouldn't adopt this [barbell] strategy," he explains.
Smith has an asset allocation of 58% corporates, 22% ABS and 20% Treasuries. At a duration of 1.71 years, the portfolio is slightly long its benchmark, the Lehman Brothers 1-3 years US Government Aggregate index, whose duration is 1.68 years.
