Steven Jones, director fixed-income at Missouri Valley Partners, will swap $50 million, or 5% of the firm's portfolio, out of mortgage-backed securities into short-term corporates in order to avoid negative convexity given his concern over potentially spiking interest rates. Jones' reasoning is to avoid holding pass-throughs that will roll up the steep curve and lengthen in duration as interest rates rise. There is no trigger for this move, besides his assumption that the economy will improve, leading interest rates to move up.
Jones says he will sell Ginnie Maes with a 30-year average life and a 6% coupon. He says he wants to sell the lower coupons first, as those will extend in duration before the 7%s. With the proceeds, Jones will "buy back convexity," investing in high-quality corporates in the short-end of the curve. As an example of bonds he may add to his portfolio, Jones cites the Textron Financial Corp. 5.95% notes of '04 (A3/A-), which he bought two weeks ago at a 220 basis points spread over the curve. Last Monday, it was trading to yield 99 basis points over Treasuries. Another potential addition is the Phillips Petroleum 8.50% notes of '05 (A3/A-), which he bought at 120 basis points off the curve. Last Monday, the spread was 151 basis points over Treasuries.
Jones manages a $1 billion portfolio out of St Louis, Mo. He allocates 52% to corporates, 34% to MBS, 9% to Treasuries and 5% to cash. At a duration of 3.53-year, the fund is slightly short its bogey, the 3.92-year Lehman Brothers aggregate index.
