Lincoln Capital Management plans to maintain its underweight position mortgage-backed securities in the coming months. Richard Knee, v.p. and portfolio manager of a $32 billion fund in Chicago, says MBS are richly valued and are trading at spreads that he considers very tight. He notes that MBS have performed well because they have exhibited low volatility, but he expects that to change and for mortgages to underperform if volatility picks up as long rates fall, which he thinks they will. Knee also thinks there is a possibility for the yield on the 10-year Treasury to fall to 3.75%, which could also lead to greater volatility. And, given that he perceives MBS are so richly valued, he says the sector has no cushion to absorb any shock from volatility or rates. Overall, this affects the risk-reward relationship and makes it relatively less attractive to hold mortgages than other bonds, he says.
Currently, the firm's holdings are roughly 10-15% less than the Lehman Brothers Aggregate Bond Index's allocation to MBS, which is about 35%. Knee declined to say whether he will further reduce mortgages and increase his underweight to the sector by letting it roll off and by adding to other sectors he feels are more attractive, such as Treasuries. Other rough allocations include $2-3 billion in asset-backed securities, with the balance in corporates and Treasuries.
