Finding Value in Fixed Income – Part II
As multi-sector fixed income investors, we have a large team of sector specialists whose job is to uncover opportunities in their sectors. In our last posting, we discussed a few bond market sectors where we see value. Here is our take on additional bond sectors in the current environment.
Agency Mortgage-Backed Securities (MBS) – The single biggest problem with Agency MBS has been the historically high price, currently just north of $108. The entire market is callable at par, putting investors at risk. This sector has been a good place to hold cash because of intensive government buybacks, but if that element goes away, we would be bigger sellers of agency debt.
Non-Agency Mortgage-Backed Securities – There hasn’t been much new production in this space, if any, but we believe that existing deals in the market still represent fair value.
Foreign (Dollar Denominated and Local) – Dollar-denominated assets have benefited from the flight to quality recently. However, local currencies of other nations provide an excellent source of diversification. Even if the euro situation is resolved soon, the secular decline of the U.S. dollar will likely continue because the U.S. has to contend with twin deficits and the year-end fiscal cliff. G-10 commodity-based currencies such as Australia, New Zealand, Sweden, Canada, and Brazil are attractively valued right now.
Emerging Markets Debt – The recent sell-off in Europe is creating potential opportunities in this sector. Some high beta names in Venezuela, Argentina, Ukraine, and Russia have cheapened considerably.
Municipal Bonds – Even though new issuance is picking up this year, it is limited and there are much fewer issues than last year. Our bias is on essential services revenue bonds, focusing on A-, AA-, and AAA-rated munis that can generate enough cash flow to service the debt, such as water, transit, schools, and Port Authority offerings. Higher tax rates are inevitably coming our way, so munis are attractive from that perspective, but the fundamental backdrop is still weak. Unfunded pension liability is massive and growing. The biggest source of revenue for local municipalities is residential taxes, and with real estate prices under pressure, the ability to raise taxes is a question for the future. That said, high quality muni assets still represent good value. We favor high quality, more liquid munis versus Treasuries where we believe we can get a multiple of the yield. In the 30-year space, some water and sewer and some university bonds are available at a multiple of 1.3 times that of the U.S. Treasury yield. Some 10-year state general obligations are also interesting, with the states we’re currently viewing, at an average ratio about 125% of the 10-year Treasury.