Sage Advisory Services is swapping 15%, or $75 million, of its $500 million portfolio, out of agency debentures into spread product, specifically corporates and mortgage-backed securities. Bob Smith, portfolio manager at the Austin, Texas-based firm, says the agency debentures are being sold because the firm believes interest rates have bottomed out, diminishing the benefits attached to owning positive convexity. Smith will seek to sell straight non-callable, or bullet, Fannie Mae and Freddie Mac bonds in the five- to seven-year sector. The firm has already begun the move.
On the purchase side, the firm will add MBS to the tune of 5% or $25 million, on the view that those bonds are more defensive in a rising interest rate environment. The bulk of those purchases will be in Ginnie Mae pass-throughs with a five- to 10-year average life and 6.50% to 7% coupons. Smith says he likes Ginnies because of their explicit government guarantee. Smith will also buy agency-backed collateralized mortgage obligations with a five- to seven-year term. In both sectors, the firm will be looking for callable features in order to add negative convexity, because should interest rates rise, price erosion will be less severe.
Smith says that the rest of the purchases will be in corporate bonds, for approximately $50 million, in the single-A sector. He reasons that corporates will outperform because of his anticipation of an economic rebound and the expectation of higher corporate earnings. Recent examples of additions include the Boeing Corp. 5.65% notes of '06 (A2/AA-) at a 150 basis points yield over five-year Treasuries. Last Monday, the bonds traded at 148 basis points off the curve. Smith believes that, given this name's leadership in the industry, the purchase represents a good credit for the next five years and will benefit from being a major government defense contractor. Another example is the purchase of Motorola Inc. 6.75% notes of '06 (A3/BBB+), bought at 350 basis points over the Treasury. Last Monday, the bonds traded at 258 basis points off the curve.
Sage's intermediate term fund has an asset allocation of 36% corporates, 36% agency debentures, 11% CMOs, 7% Treasuries, 7% cash and 3% asset-backed securities. With a 3.09-year duration, the firm is slightly shorter than its benchmark, the Lehman Brothers government/corporate intermediate index, which has a duration of 3.67 years.
