Jim Dugan, portfolio manager at Cavanaugh Capital Management, is looking to rotate 12% of the firm's portfolio, or $78 million, out of corporates and into mortgage-backed securities. The move will be triggered once the 10-year Treasury yield backs up to 4%; the bond was yielding 3.67% last Tuesday. Dugan wants to see some of the pressure on prepayment risk diminish before purchasing MBS, which he says is likely to occur given the steep drop in Interest rates.
Dugan will be buying five- and seven-year balloon bonds guaranteed by Freddie Mac, Fannie Mae and Ginnie Mae. He also will consider 15-year pass-throughs from the same issuers. He wants to minimize extension risk, which is why he will stay away from conventional 30-year mortgages. Dugan says that selling corporates will make sense if spreads continue to tighten, especially in the industrial sector, where performance has been best and where he will concentrate his sales. Unlike utilities or industrials, financial corporate bonds have not performed well lately which is why Dugan is not considering selling them at this time.
Dugan manages a $650 million portfolio out of Baltimore. He allocates 27% to corporates, 25% to taxable municipals, 22% to MBS, 15% to agencies, 8% to Treasuries, 2% to cash and 1% to asset-backed securities. With a 3.80-year duration, the fund is slightly shorter than its 3.94-year bogey, the Lehman Brothers aggregate index.
