Fischer Francis Trees & Watts is increasing its holdings of 10-year U.S. TIPS and will finance the move by selling off the short and long parts of the U.S. TIPS curve. Paul Zhao, head of global inflation-linked bonds, said this relative value play goes against consensus strategy to barbell duration. As a result, he thinks the 10-year is cheap due to oversupply and the short and long ends of the curve are rich due to demand from investors pursuing the barbell strategy.
Zhao manages $2 billion in global inflation-linked securities, $1 billion of which is invested in U.S. TIPS. He declined to specify how much of the 10-year TIPS he would buy, but said these securities account for 25% of his portfolio.
Zhao said he will buy the January '15 and July '14 TIPS and could sell any TIPS shorter than the January '10s. On the long end, he could sell the January '25, April '28 and April '29 TIPS. "Investor positioning in this rising-rate environment tends to barbell but valuation [at the ends of the curve] is extreme," he explained. The manager added supply of 10-year TIPS is outstripping demand, with issuance four times that of five-year TIPS.
In addition to his curve strategy, Zhao recently employed a trade based on the relative value between nominal Treasuries and TIPS. The manager recently slashed his 15% position in nominal Treasuries to zero because the difference between the yields of 10-year TIPS and nominal Treasuries narrowed. "Inflation fears were too persuasive to have such a big position in nominals," he noted.
Zhao's benchmark is the Lehman Brothers U.S. TIPS index. His duration is near his bogey's nine-year duration.
