Finding Value in Fixed Income – Part I
As deep value investors, we look for opportunity across all 14 sectors of the bond market, which, in aggregate, adds up to about $22 trillion – five times the size of the equity markets. A number of fixed income sectors continue to represent great value and returns across the board.
Senior Floating Rate Bank Loans – This is one of our favorite sectors for volatile markets because of its defensive posturing, lack of a maturity wall (only $40 billion is due at the end of 2013), and very positive fundamentals. Since the Fed’s June 2011 announcement to keep interest rates low for 24 months, the sector was pummeled by 34 straight weeks of redemptions, but as we wrote a few weeks ago, the sector has seen recent inflows. Last year, loan defaults were virtually non-existent – there were only five – and the running average for defaults right now is under 1%. With spreads in the LIBOR +600 bps range, now is an opportune time to own bank loans.
Investment Grade Corporate – Last year, the industrials and utilities sectors did very well, while financials got pummeled. This year has been the opposite, with insurance, regional banks, REITs, and financials doing well early on. Financials have the potential to return in the 5% to 7% range this year, and industrials and utilities to return 2% to 3%. Our bias is towards BBB-rated corporate bonds.
Domestic High Yield – This sector has done very well this year. Spreads have recently widened due to the tumult in Europe. Our bias is up in quality in this sector. BB-rated issues are pricing in the chance of recession at 51% and still represent good value.
Asset-Backed Securities – Our smaller (under $10 billion) portfolio size has allowed us to take advantage of opportunities in “off the run” deals in a couple of BBB-rated franchise receivables.
Commercial Mortgage-Backed Securities – Thisarea still represents excellent value. This market, unlike residential, has allowed for refinancing and the ability to amend and extend. Liquidations and losses have never materialized. Losses are running slightly above 1%, with defaults peaking at 10%. We like “super duper” senior tranches of structured transactions as these deals can withstand twice the worst year in the history of defaults and losses.