Cavanaugh Capital Management is selling intermediate sector treasuries and buying intermediate agencies because of the attractiveness of agency spreads on a historical basis, according to President Jim Dugan. Dugan characterizes this move as a rotation from a treasury allocation of 35% to about 23%, or $65 million dollars, noting that he is about halfway done. He says that in addition to the possibility of capturing some spread tightening in the GSE paper, he also sees the three- to seven-year treasury market as being at the tail end of a year-long rally, and is anticipating a gradual back-up in rates as economic growth slows and inflation trends (slightly) north.
Dugan and his team began putting the trade on in mid-March when these bonds were trading at 65 basis points off the Treasury curve. With the paper now quoted 53 off the five-year, he notes the bonds historically have been as tight as the low 40's, but would not comment on where he would look to reverse the position. His agency position is entirely in non-callable, or bullet, paper, and is concentrated primarily in off-the-run five-year paper, with '05 and '06 being the principal maturities. Dugan is concentrating primarily in Freddie Mac and Fannie Mae bonds, but has also bought Federal Home Loan Bank paper as well.
The fund has assets of $535 million and an allocation of 35% MBS, 27% treasuries, 18% taxable municipals, 15% agencies and 5% cash. The duration of the fund is currently 3.7 years, versus that of its benchmark, the Lehman Brothers intermediate government/credit index, at 3.62 years.
