Andres Capital Management may add to its holdings of hybrid adjustable rate mortgages to protect itself against the outside risk of a spike in interest rates. The manager may add a few million dollars to its holdings of 5/1 hybrid ARMs, pushing the sector to 5% of the portfolio, according to Jonathan Smith, president. Smith runs $130 million in taxable fixed income from King of Prussia, Pa.
Smith prefers 5/1 hybrid ARMs over general pass-throughs because they are less susceptible to extension risk as interest rates rise. The manger recently bought a Washington Mutual 4.27% '35 5/1 hybrid ARM with whole loans instead of agencies for collateral. The whole loan-based product is yieldier, Smith explained.
Smith is overweight mortgage-backed securities, slightly underweight Treasuries, underweight corporates and roughly equal the index in agencies. He prefers MBS because triple-B corporates are only yielding 5-10 basis points more than triple-A MBS, he said.
Smith is also moving up in credit quality within corporates, going from triple-B securities to single- or double-A bonds. The asset manager is making this move now as he is not being adequately rewarded for the extra credit risk, he said.
Within agencies, Smith is buying one-time callables with a three-year call and a five-year final maturity. These agencies yield 30-40bps over comparable bullets and are preferable to longer callables because it is easier to forecast the chances of being called away over a shorter horizon, Smith said.
In Treasuries, Smith is pursuing a barbelled strategy overweight in one-to-five year securities and bonds 10 years and longer. But he cautioned the juice is being squeezed out of this trade as the curve has been flat for so long.
Smith benchmarks his assets against several indices, including the Lehman Brothers Aggregate Bond Index. The firm is neutral the duration of its index at 4.42 years.
