Bryan Johanson, portfolio manager with C.S. McKee & Co., will rotate $22 million, or 3% of a $730 million fund he manages, from 10-year Treasuries Inflation Protected Securities (TIPS) into 10-year Treasuries. The move will be triggered when the 10-year Treasury yield reaches 5.38%. Last Monday, the 10-year yielded 5.28%.
Johanson says the move combines a relative value and duration play. Although the two types of swapped securities have an identical 10-year term, their respective duration differ and the move aims to extend the portfolio's duration from 4.88 years to 5.0 years. The 10-year TIPSs have a 3.3-year durations while the 10-year Treasury's duration is 7.0-years. At the same time, in a falling interest rate environment, Johanson says that 10-year Treasuries will have a much greater price appreciation than comparable TIPSs. Asked why he sees interest rates moving lower, while others speculate the Federal Reserve may raise Fed fund rates as early as mid-year, Johanson says that Treasury yields do not necessarily reflect Fed fund rates and that the market has already priced in more tightening than is likely to occur. For instance, Fed fund rates were cut by 425 basis points last year, yet the 10-year Treasury yield remained unchanged. For this year, Johanson predicts the 10-year Treasury yield will drop below 5% as his firm is not bullish on the stock market and rather bearish on corporate earnings. In addition, with the job market still sluggish, Johanson believes that the Fed will wait at least two full quarters after the job market recovers before raising rates.
Johanson manages a fund that allocates 33% to mortgage-backed securities, 25% to corporates, 15% to Treasuries, 10% to closed-end mortgage mutual funds, 5% to TIPS, 5% to asset-backed securities, 4% to agencies and 3% to commercial mortgage-backed securities. The fund is slightly long its bogey, the Lehman Brothers aggregate index, which has a duration of 4.69 years.
