Nelson Capital Management plans to swap 5% of its portfolio, or $10 million, from Treasuries into agencies. Melissa Parker, portfolio manager with the Palo Alto, Calif.-based investment firm, says she is doing this because agency debentures spreads have recently tightened as a result of the market-wide flight to quality induced by the terrorist attacks. As an example, Parker says five-year Fannie Mae debentures were yielding 68 basis points over the five-year Treasury on Sept. 10: last Monday, the spread over Treasuries tightened to 54 basis points.
Parker says she will implement the rotation should the yield curve further steepen. As a trigger, she will watch for the spread difference between two-year and 30-year Treasury bonds to increase from its current 250 basis points to a wider 300 basis point spread. The firm buys Agencies all across the spectrum, including Freddie Mac, Ginnie Mae, Fannie Mae and the Federal Home Loan Bank.
Parker says she most likes step-up agencies. If the bond does not get called, it becomes a bullet with a higher yield. As an example, the firm recently bought 4.05% Fannie Mae bonds, callable in 2002. If the bond is not called by then, the coupon will step-up to 5% until the 2006 final maturity and will not be callable after 2002. Parker says that even if the bond gets called, she gets over 4% yield on a one-year term, a rate of return she says is worth the risk.
Parker manages a $200 million portfolio which has an asset allocation of 40% agency debentures, 40% corporate bonds and 20% Treasuries. With a 3.68-year duration, the fund is neutral to its benchmark, the Lehman Brothers Government credit intermediate index, which has a duration of 3.68-years.
