HighMark Capital Management is preparing to sell longer-term corporates and buy shorter agencies and ABS for 20% of its portfolio, which would be an $800 million move. The move will shorten duration by 15%, in two progressive stages, aligning the duration to the benchmark by the summer, and shortening it by 5% by year-end, in anticipation of a corporate bond sell-off likely to take place in the second half of the year, after interest rates bottom out this summer, says Richard Grahman portfolio manager at the San Francisco-based investment firm.
The shortening will consist of reducing the 6-7 year average life of the currently held agencies into a 3-5 year range; similarly, the ABS average life will be reduced from 8-year to 4-5 year. Grahman sees treasury yields going down this summer, before going up again by year-end. His target 10-year treasury rate is 4.50% this summer to go up to 5.25% by year-end, and from 4.75% this summer to 5.75% by year-end, for the 30-year benchmark. In the fourth quarter, clear signs of next year's shrinking of the Government surplus will constitute buying signals for the treasuries, says Grahman, who will look at buying them again, then.
Due to increased risks of recession and therefore, increased credit risk, another way to shorten the portfolio will consist of rotating a corporate bond into a shorter-term ABS from the same issuer in order to achieve credit enhancement. Grahman believes a recession scenario is likely to happen if the unemployment rate exceeds 5%, a probability he evaluates at 60%, or the industrial production continues to drop for another couple of months.
An internal benchmark allows the portfolio manager of this firm to rotate up to 5% of the assets under the same issuer's name from a corporate asset category into its ABS counterpart, and Grahman intends to use it for most of its automobile corporate bonds, such as the Ford (A2/A), GMAC (A2/A), DaimlerChrysler (A3/A-) and Toyota (Aa1/AAA). Those bonds have a 5- to10-year maturity range and offer 5-6.75% coupons ranges.
The $4 billion portfolio has an asset allocation of 70% corporate, 10% ABS, 10% MBS and 10% agencies. At a duration of 5.06, the portfolio is longer its benchmark, the Lehman Brothers aggregate index whose duration is 4.60 years.
